The true power of a candlestick pattern is only unleashed when it appears at the right location on a chart. For instance, a bullish reversal pattern is most effective when it forms after a price decline.
Based on my experience, most traders find that patterns like the hammer, shooting star, engulfing, and piercing patterns work best for them.
Regardless of the timeframe (5min or daily or weekly), candlestick patterns work the same way. The shape of a pattern reveals the psychology of the market. Reversal patterns, for example, signal a shift in power from bulls to bears, or vice versa.
A breakout above a high or a breakdown below a low gives you an entry point.
Candlestick patterns can be a complete trading strategy on their own or they can be used as a part of a larger strategy. For e.g.:
You can buy a stock simply because a hammer pattern has appeared
Alternatively, you can use a breakout-retest strategy. In this case, a hammer at the retest level provides confirmation and confidence to make a buy decision.
One of the most common mistakes traders make is spotting reversal patterns in a sideways market. For e.g. a hammer found within a sideways trading range will not work as intended. This is because a hammer is a reversal pattern - it requires a downtrend to “reverse.” It must come after a decline and not in a sideways market.
That’s it, folks! Thanks for taking part in our LIVE AMA and asking all your questions. To know more about how candles work, you can check out this course: Japanese Candlesticks Crash Course - Uplearn
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It is an interesting question. Algo-dominated markets may reduce the effectiveness of reversal patterns, to a certain extent, due to the noise, false signals or simply SL hunting.
That is the reason most Pro-traders use candlestick patterns along with confirmations of other tools and indicators such as volume, RSI divergence. Similarly, one can also observe charts on different timeframes to get a better picture of the overall market direction.