In the early days, I had ( like most of us I am sure ) come across the so called candle stick patterns that would somehow dictate the direction of price. Now, I am not saying they are not or they are correct/incorrect, I am actually trying to figure this out while practicing my programming skills. I know, just by simple understanding of order flow and price action, that these patterns do dictate price direction, but are also just as part of the noise as any other candle. Obviously, no single signal can be the end to a means, so we will try to analyze the patterns with other indicators to find confluence , and then back test and so forth.
So, what are these patterns?
There is quite a few of these, and there are a lot more than just the ones shown here. For now though, I will just focus on these.
So, this experiment, I believe, could show us a couple of things.
- surely, these patterns have some validity, of course the question is how much. And surely, the patterns make more sense and have more validity in higher time frames, away from the static and noise.
- Clearly, when you think about the order flow that would create these patterns, it makes sense, maybe in a lower time frame, but more so in the higher time frame ( where static is not represented )
Could it shows us anything else? Maybe, and that would be great. But again, this is all for my own selfish entertainment and practice. I really don’t expect anything to be learned from this.
So lets get it going.
Firstly, we need to define what a pattern is. Lets start with the engulfing pattern. This, in of itself is very much a viable and valid set up, I just don’t know I would enter on the next candle opening every time, or at all. There could be a host of situations and variables that could change the probability of this pattern turning out for us.
The main part of the engulfing pattern is that the close, high, and lows extend beyond those of the previous candle, and that the presumed direction is then in the same direction of the engulfing candle. The image here shows a gap in the original impulsive move like a dark cloud cover or rising sun, but the difference ( and the most important part I believe to be part of this is the closes and wick/shadow go further than before ) .
So first we will just set up the check to see if the second bar meets this criteria and set an order where the stop loss will be a static level of 1:1.5
no good. As suspected, it is opening way to many trades, and more importantly, trades are opening in opposite direction ( hedging not allowed in the states! ) and at the same time making this result very dirty.
Lets prevent it from opening another trade while one is opened.
So we prevent more than one trade at a time, and set it to set the stop to the largest swing in the last ten bars and the take profit be 1.5 that same distance
and what do we have here? 40% win rate, and a profit factor of 1.1 with a 39% drawdown. Not stellar , but maybe there is some truth here.
Lets first set a break-even system to see if it improves the situation any. I think a break even should occur when the price gets to the half way point between entry and take profit.
Not so much….. The drawdown went to 59% and as you can see, the last few years of testing is very negative . At least before without the break even, it was break even in the last few years.
So continuing on , I tried only taking trades in the direction of a proposed trend based on where price was relative to a 20ema , much worse numbers. I tried adding to see if the stochastic is above or below a certain level, no better.
So looking back at the original number ( taking every trade with this setup ), this was the result
Not to shabby. 38% drawdown, 1.08 profit factor 30% win rate.
I mean, not to shabby for taking every single engulfing pattern.
Until we look at higher time frames
Clearly, engulfing patterns ( and probably every pattern ) is not a signal in of itself. But taking every single one can lend to some descent results in the near past, maybe,…. hopefully??? I personally, would use them ONLY in conjunction with some other indication. Obviously, something like a pattern isn’t going to be the one indication of a winning trade.