### Do Candlestick Patterns Work ?

Recently, I have been exposed to a lot of material on candlestick charts (Japanese Candlestick Charting Techniques, Candlestick Forum). I really like the intuitive look and feel of a candlestick charts.

Generally speaking, quantitative trading and chart patterns do not work well together. Candlesticks make it easier. In candlestick parlance, a doji is formed when a security closes very near its open price. From a quantitative perspective, I could spot a doji as follows :

$\frac{Abs (Close[bar]-Open[bar])}{High[bar] - Low[bar]} < 0.15$

Doji as a trend reversal signal

Conventional wisdom states that the doji is a trend reversal signal. It signals a 'draw' between the buyers and sellers. If a doji shows up at end of consecutive down days, it may mean that the down trend is coming to an end.

Back testing the Idea

Let us back test this idea. I will set up my test as follows :

DataSet : SP500
BackTest Period : 15 years

Condition 1 : Look for 5 consecutive down days
Condition 2 : A doji is formed on the sixth day

Buy At Open on the seventh day

Sell Signal:
Sell on the eighth day

BackTest Results
Net Profit($7,782.10)Number of Trades3,403 Profit per Bar($1.14)Average Profit($2.29) Total Commission($13,612.00)Average Profit %0.04%
Average Bars Held2
Win Rate52.72%Loss Rate47.28%
Gross Profit$152,433.90 Gross Loss($160,216.00)
Average Profit$84.97 Average Loss($99.57)
Average Profit %2.69%Average Loss %-2.92%
Average Bars Held2Average Bars Held2
Max Consecutive Winners36Max Consecutive Losses18

The theory is impressive. The name of the signal is impressive. The back test results are NOT. And this leads me to question. Do candlestick patterns work?

1. dojis aren't meant as a stand alone reversal signal but more of a point of indecision. you can trade the break of the high or low of the doji to confirm a continuation or a reversal. the only time i'd consider trading a doji is if i'm at a key s/r level, otherwise i want confirmation that the trend is either over or continuing

2. When you test any pattern (like this one), the results are clear -- assuming you tested what you intended (i.e. the signals actually reflect the concept in your mind, or what your trying to match to). I don't know if the doji works -- you might expand the requirements per the comments by Anonymous above, i.e. add more strength requirement. Support / Resistance is somewhat subjective -- but a break above the N bar high is not. Report back and let us know what you think.

3. I agree, they cannot be used as a stand alone signal. In the case shown above, I am trading a doji after 5 down days. The 5-down day condition acts as an 'oversold' condition.

I am starting to think about using doji with S/R lines. I will be doing some work on it very soon

4. I have been trading candle stick patterns for the last three yrs very successfully. The key to success in not to use them alone. The are as many random (unprofitable) ones as profitable. I use added confluence such as support/resistence, fib retracements, moving averages. Once I have added confluence with the overall trend I take the trade on end of day bars.

5. I agree with Jay McKean, candlesticks should be used together with other, western signals, not alone