Careful study of candlesticks patterns on a market chart (SPY or S&P 500), can provide high probability signals relatively to the direction of the market. Below we will study ETF SPY chart from October 2011 until June 2012 and demonstrate that many times candlesticks patterns signaled with accuracy short term reversals, although other times might not have predicted right. We will fragment the above period in three sub periods in order to have clearer visual representation of the charts. Trading clear candlesticks patterns which are formed near supports/resistances is strongly recommended in order to avoid false signals.
Point 1: Piercing line closely to a prior support (not shown in the chart for practical reasons). This is a very high probability bullish reversal.
Point 2: Inverted hammer after a steep downtrend. The only reason for concern here is that it is not formed near a support.
Point 3: Bullish kicking after a downtrend on a previous support shows a violent psychological shift of market participants. This is a very high probability bullish reversal.
Point 5: A marginal bearish harami which gave false signal.
Point 6: Bullish harami near a support level (not shown in the chart for practical reasons). This is a high probability bullish reversal.
Point 7: One white soldier on a support level (not shown in the chart for practical reasons), gives a very short term and faint reversal. Although this is a high probability reversal, it didn’t work out as expected.
Point 8: A hammer followed by a bullish engulfing on a prior support (not shown in the chart for practical reasons), gives a bullish reversal. The fact that the hammer didn’t gap down is something that we must take into consideration before opening a position, but the bullish engulfing of the next day migrates the danger of a false signal.
Point 9: It is like a bullish stick sandwich but without a prior downtrend. Surely it is not signaling a reversal but it might be signaling continuation. Candlesticks patterns in a real chart are not formed exactly as their prototypes many times. The formation here is quite peculiar and we wouldn’t have opened a position without second thought.