Candlestick patterns are quite popular in forex trading, but not many people actually know which patterns are the most valuable. Read further to find out.

5 Most Important Candlestick Patterns for High Profits

Candlesticks are a type of technical analysis that can help traders make better predictions about the market. They are more informative than traditional bars and can be used to identify patterns that indicate the strength of an upcoming trend.

Many candlestick patterns exist, but some are more effective than others. The five most essential patterns are:

  1. The Pin Bar
  2. Bullish and Bearish Engulfing Patterns
  3. Doji Bars
  4. Inside Bars for Reversals and Continuations
  5. Three-Bar Reversal Pattern

The patterns mentioned are essential because they are easy to identify, historically accurate, and reflect significant market actions that usually lead to major reversal or continuation.

Let's discuss them one by one.

 

1. The Pin Bar Reversal Pattern

Pin bars are arguably the most effective ways to trade candlesticks because the pattern tends to create a high probability of price action. Generally, pin bars represent an event in the market that affects sellers and buyers. A pin bar reversal usually consists of a long tail, known as the "shadow" or the "wick".

A candlestick with a longer upper axis indicates the sellers' strength, whereas a longer lower tail indicates the buyers' strength. The area between the open and the close of the pin bar is called the "real body", and pin bars usually have a small body compared to their long tails. The pin bar's tail shows the area of the rejected price, indicating that the price will move opposite to the direction of the tail point.

A bearish pin bar reversal would have a longer upper tail and a bullish pin bar reversal would have a longer lower tail.

Take a look at the chart below.

Pin bar reversals pattern chart.

We can see that there are two pin bars in the chart. The first one is bullish, and the second is bearish. Now the way to use them is to wait for the price to break above or below the high or low. When that happens, you enter the market.

Remember that pin bar setups are triggered once the price of the following candlestick breaks above the body of the pin bar. Once triggered, you can look for the following support and resistance levels to find your primary profit target. If you are a short-term trader, we recommend you set your risk with a risk to reward ratio of 1:3.

If you find pin bars forming at the extreme high or low of a sustained trend, then it means that the price would go on a complete reversal of the prevailing trend. Therefore, it would be wise to trail your open position based on ATR or X-bar stop losses, as it can maximize your long-term profit.

 

2. Bullish and Bearish Engulfing Patterns

Like pin bars, bullish and bearish engulfing patterns also signal a reversal of the previous trend. Such patterns are called Bullish Outside Bars (BUOB) and Bearish Outside Bars (BEOB).

Bullish engulfing patterns are characterized by a bearish candle followed by a bullish one that engulfs the smaller bearish candle. It means that the buyers have overtaken the sellers and increased the price. Usually, such patterns can be found at the end of a downtrend. In contrast, if the closing price is lower than the opening price and happens at the end of an uptrend, it is a bearish engulfing pattern.

Bullish and bearish engulfing patterns.

Based on the chart above, we can see that a large bearish candlestick has engulfed the previous, smaller, bullish candlestick. In this case, it would be wise to place a sell stop order a few pips around the pattern's low and target the next pivot zone. This would likely be a win with a decent risk to reward ratio.

While it's best to search for engulfing patterns at the top or bottom of a trend because it indicates an upcoming reversal, you can also use these patterns to trade in a more range-bound market. It's common to find engulfing patterns breaking above or below a range, which helps make some nice breakout trades.

Remember that engulfing candlesticks are usually longer than pin bars, so you should place your stop loss relatively high. One way to do this is by drawing Fibonacci retracements based on the high and low of the engulfing bar itself and setting a stop loss at a certain Fibonacci level.

 

3. Doji Bars

A doji candlestick typically shows indecision in the market and a potential change of direction. A doji forms when the opening and closing prices are almost at the same level, indicating that the market has not decided which direction to go. If there is a difference between the opening and closing price, it's normally small, only about a pip or two.

Since a doji formation means indecision in the market, the trend can change direction or stay on the same path. One thing that you should consider is the location of the doji bar. If the doji forms during a strong trend and the next price breaks above the pattern, it can be interpreted as a continuation signal. If the opposite scenario happens, the price will change direction soon.

Several types of doji bars are based on the direction where the price moved first before it reversed. One of them is called a star doji. This pattern is formed when the high and low are equal distances from the open and closing prices.

Apart from that, there's also the gravestone and dragonfly doji, characterized by the price that moves up and down but returns to close at the opening price. These two patterns look like the letter T and an upside-down T.

Doji bars signal indecision chart.

The chart above shows that a doji was formed at the end of a downtrend. As the next price broke above the doji's high, it indicated a reversal to the upside. You could enter the market directly or increase your long exposure by placing a buy stop order a few pips above the high of the Doji.

 

4. Inside Bars for Reversals and Continuations

Inside bars are quite special because they can signal trend reversal and continuation, depending on where they form in the chart. The shape and size are the opposite of engulfing patterns. Inside bars have high and low that are shorter than the previous bar and sit inside the previous bar's real body.

However, trading with this pattern means you must wait for the price to break above or below the high or low of the previous bar's high and low. Take a look at the chart below for a clear example.

Inside bars for reversals and continuation chart.

The chart shows a large bearish bar, followed by a small bullish bar formed within the larger bar's real body. Inside bars like these can range from a single bar to several at once consecutively. It doesn't matter if the larger bar is bullish or bearish.

As long as the smaller bars stay inside the range of the larger bar's body (the "mother" bar, the pattern successfully indicates the start of a momentum trade. The chart above shows that the price broke above the low of the mother bar, which triggered a bearish trend.

It can also mean a continuation signal if you find inside bars during a strong trend. In any case, you can set your stop loss above or below the mother bar. If your strategy requires a smaller stop loss, it's also a good idea to set the stop loss above or below the range of inside bars. Such action is rather risky for beginners, so if you're a beginner, we recommend setting your stop loss around the mother bar.

 

5. Three-Bar Reversal Pattern

Three-bar patterns s are easy to identify because they only consist of three consecutive bars moving in the same direction, each going higher or lower than the previous bar. There are two types of three bars. The first is the Three White Soldiers that signal a bullish reversal while the second is the Three Black Crows that signal a bearish reversal.

Three bar reversal pattern chart.

We can see that on the chart above, there are three bearish bars formed. You can see that as soon as the price broke below the low of the lowest bearish bar, the downtrend continued. In some cases, after the low is broken, the price would retrace a bit before going back down.

Next, you would want to set your stop loss above the high of the highest Crow. This is a good point to exit the market. The opposite rules can also be applied to the Three White Soldiers pattern.

 

Bottom Line

As a trader, it's important to identify the most valuable candlestick patterns. While there are hundreds of patterns out there, only some of them work well. So instead of memorizing them, you can pay attention to the most effective ones. As long as you understand the patterns correctly, they will give you an excellent insight into the market sentiment.

Don't forget always to wait until the pattern is completely formed before taking action. You can place a buy or sell stop entry order above or below the candlesticks so you will enter the market right when the trade confirmation happens. Also, while you're at it, try to combine the candlestick patterns with other indicators.