[Update 2020] I wrote this post back in 2006 when I was just starting day trading. I have decided to review and update this post. The materials presented in this post are still applicable and useful to beginner traders.

I am hitting the wall while working on backtesting programming. I decided to take a break and write a post about candlesticks stuffs that I have recently learned. There are just too many patterns of candlesticks. And I was confused. And I was pissed. And I gave up.

I know the value of candlesticks for day trading. With help from Dave, I am looking at a couple of useful patterns and trying to integrate into my backtesting program of the dummy system. I tried to search on the internet, books and I have sorted out these few valuable patterns.

14 Most Useful Candlesticks Patterns

Abandoned Baby

A long black day is followed by a Doji that gaps in the direction of the trend. Then a white day occurs gapping in the opposite direction with no overlapping shadows.

In a downtrend or within a pullback of an uptrend, the market gaps down but does not continue its downward movement. Instead, enough bulls step up to bring supply and demand back into equilibrium and the stock churns in place. This isn’t necessarily bullish, but it’s certainly less bearish. The pattern is confirmed by the next day’s gap up and rally.

Doji Star

A long black day is followed by a Doji that gaps in the direction of the trend. The shadows of the Doji should be short.

In a downtrend or within a pullback of an uptrend, the market gaps down but does not continue its downward movement. Instead enough bulls step up to bring supply and demand back into equilibrium and the stock churns in place. The halt of the downtrend signifies the possibility of a reversal, so confirmation is needed with a strong third day (preferably with volume behind it).

Kicking

A Black Marubuzo (open is the high of the day and the close is the low of the day) day is followed by a White Marubuzo (open is the low of the day and the close is the high of the day) day that gaps in the opposite direction.

The current trend is not very important with a bullish Kicking pattern. The fact that the stock can gap up and rally to close at its high is bullish regardless of the previous trend. Use volume on a white day to confirm the movement.

Mat Hold

A long white day in an uptrend is followed by a relatively small black day that gaps in the direction of the trend. The next two days continue the brief pullback and are small days that stay within the range of the first day. The fifth day is a long white day that closes above the close of the first day and continues the uptrend.

In an uptrend, a long white day is followed by a brief pullback (preferably on lightish volume). The fifth day simply continues the trend. The brief pullback is nothing more than a few days off for the bulls.

Matching Low

A long black day is followed by another black day with equivalent closes both days.

In a downtrend or during a pullback within an uptrend, a long black day occurs signaling the bears being in control. The stock gaps up the next day but then sells off to close at the same level as the previous day. The more times a stock can successfully test and hold a low, the higher the chance a reversal will occur once the seller become exhausted. Strength the following day with volume would confirm the pattern.

Morning Doji Star

A long black day is followed by a Doji that gaps in the direction of the trend. The third day is a white day which closes in the top half of the black day.

In a downtrend or during a pullback within an uptrend, the market gaps down but does not continue its downward movement. Instead enough bulls step up to bring supply and demand back into equilibrium and the stock churns in place. This is the bullish Doji Star formation. A subsequent follow through gap up that closes above the midpoint of the black day completes the Morning Doji Star and confirms the reversal.

Evening Doji Star

A long white day is followed by a Doji that gaps in the direction of the trend. The third day is a black day that closes in the bottom half of the white candle.

In an uptrend or within a bounce of a downtrend, the market gaps up but does not continue its upward movement. Instead enough bears step up to bring supply and demand back into equilibrium and the stock churns in place. This is the bearish Doji Star formation. A subsequent follow through gap down that closes below the midpoint of the white day completes the pattern and confirms the reversal.

Evening Star

A long white day is followed by a small body that gaps in the direction of the trend. The third day is a black day that closes in the bottom half of the white candle.

In an uptrend or within a bounce of a downtrend, the market gaps up but does not continue its upward movement. Instead enough bears step up to bring supply and demand back into equilibrium so a small body forms. A subsequent follow through gap down that closes below the midpoint of the white day completes the pattern and confirms the reversal.

Morning Star

A long black day is followed by a small day that gaps in the direction of the trend. The third day is a white day which closes in the top half of the black day.

In a downtrend or during a pullback within an uptrend, the market gaps down but enough buyers step in to halt the weakness. The lack of ability of the bears to press the issue indicates the downtrend may be weakening. The gap up and rally that closes the white day above the top half of the black day confirms the reversal if accomplished with a surge in volume.

Three Inside Up

A bullish Harami pattern is followed by a white day that has a higher close than the second day.

In a downtrend or during a pullback within an uptrend, a bullish Harami pattern forms. This pattern has low reliability, but when it is followed up with another white day, a reversal becomes much more probable ? especially when accompanied by volume.

Three Outside Down

A bearish Engulfing pattern is followed by a black day whose close is lower than the second day.

In an uptrend or within a bounce of a downtrend, a bearish Engulfing pattern forms. By itself this pattern has moderate reliability as a reversal indicator, but when the it is followed by another black day (preferably on strong volume), the overall pattern becomes much more reliable.

Three Inside Down

A bearish Harami pattern is followed by a black day whose close is lower than the second day.

In an uptrend or within a bounce of a downtrend, a bearish Harami forms. By itself this pattern has moderate reliability as a reversal pattern, but when followed by a weak day (preferably with a pick up in volume) the overall pattern becomes much more reliable.

Three Outside Up

A bullish Engulfing pattern is followed by a white day whose close is higher than the second day.

In a downtrend or during a pullback within an uptrend, a bullish Engulfing pattern forms. By itself the pattern has moderate reliability as a reversal indicator, but when the it is followed by another white day (preferably on strong volume), the overall pattern becomes much more reliable.

Dark Cloud Cover

A long white day is followed by a black day which gaps above the high of the white candle and then closes below the midpoint of the first day’s body.

In an uptrend or within a bounce of a downtrend, the stock gaps up and immediately encounters sellers who push the stock back down. This simply signifies the possibility of a reversal that is more reliable if the gap up occurs at resistance and the black day is accompanied by a surge in volume.

Most Useful Candlesticks Patterns – Closing Words

There you have it. My list of most useful candlesticks patterns for day trading.

However, bear in mind that these are not holy grails. The best way to use any market pattern is to play it with the context of the market.

Understand the context of the market, define your trade location, and look for your favorite chart or candlesticks patterns to play out.

If you are looking to learn more about trading, remember to check out the Back To Basics series of blog posts. I have compiled a list of articles that I feel are useful to beginners’ traders.

Also, feel free to check out the Resource page to see the tools I use in my trading.

That’s it.

Be a Better Trader, Today.

This website is free and supported by readers. This post may contain affiliate links. Read the disclosure for more info.

I have been thinking about writing something on money management, I just didn’t know where to start. Of course, I do not claim as an expert on this topic, I am just sharing materials I have learned.

Accuracy vs Risk-Reward Ratio

There are times I read traders’ blog who revealed their risk-reward ratio when making certain trade. Some traders are trading with 1 R in order to earn 0.3R (basically, risking $100 to earn $30, that’s the idea).

There is nothing right or wrong in the trading business, I am not arguing if the trader is doing the right thing. I am interested in looking at some simple mathematical details of this risk plan.

Accuracy or winning rate is the percentage of winning after a serious of trades.

Just how much accuracy is required from your system for you to be profitable after a certain number of trades when you are risking, say, $100 to earn $30 each trade?

Accuracy = (Number of wining trades/Number of losing trades) x 100%

Risk-Reward Ratio is the ratio of the amount you will lose if a trade is stopped out and the profit amount if a winning trade is closed.

Risk-Reward Ratio = $loss/$Win

I found an excellent spreadsheet from Kreslik.com (An excellent forum, with some great traders sharing strategies, programming etc). I have recreated the spreadsheet and it can be found here. moneymanagementchartupload.xls

Feel free to download a copy and play around to get the idea.

Let’s take an example, risk amount $100, profit target $30.

As you can see, with this risk-reward ratio, you will need a system/methodology that gives 80% accuracy in order for you to be profitable.

A system with over 80% accuracy?

Well, I believe it does exist, but I have no luck to see it so often. Most of the time, I will be happy if my system gives me over 60% accuracy or sometimes, just around 55% accuracy.

This time, I am risking 1 R in order to earn just 1.5 R (risk $10, to earn $15).
Here is the result.

Basically, it is just like a coin tossing game, I need 50% accuracy in order to be profitable.

How about risking 1 R to earn 1 R?

Not a good idea. Remember, commission kills.

For example, we assume each trade, $4 is required for the round-turn commission. With a 1:1 risk-reward ratio, over 100 trades, we are still at the losing end, if our system is unable to produce 53% accuracy.

You can try out different Risk/Reward combinations in the spreadsheet.

Accuracy vs Risk-Reward Ratio – Final Words

Some simple calculations do help traders to understand the nature of trading. It is crucial to have a good understanding of these concepts between you start trading.

Trading is a long game. Having a good understanding of risk management will go a long way.

If you think it is ok to risk bigger dollars to earn a small profit, make sure you have a high accuracy system that pays you.

Tool I use

The Advanced Calculator from Forex Smart Tools is one of the best retail money management tools I have used. It helps to calculate and fine-tune my overall risk plan before I put on a trade.

It is a robust tool that caters to different trading styles including cost-averaging, stop-and-reverse, and multi-leg positions, etc.

If you are interested in finding more about the journaling tools I use in my trading, check out the resource page for more details.

What is your winning rate and risk-reward ratio in your trading? Which money management tool do you use for your trading?

Do you have any questions or comments? Please feel free to drop me a line in the comment section. I am happy to help.

Here is another masterpiece I found from Linda Raschke‘s articles.
I would only list out the key points which I have found to be useful for me to write my trading business plan.

Here is a list of some of the types of things you can include in your annual business plan. The list will give you something to work on. Start thinking about putting together a professional program, comprised of bite-size pieces.

Tips for Writing A Business Plan For Traders

What methodology or patterns are you going to trade?

It is OK to have a “library” of setups, but most people do best concentrating on a niche or particular technique. Learn to do one thing consistently well instead of trying to master too
many styles.

Which markets are you going to trade?

If you trade equities, think about keeping a “stable” of stocks to follow. Don’t get caught up in scanning a database of too many issues that you are not familiar with. It invites unfortunate
situations where there may be pending issues or reports in the company that you are unaware of.

If you have not had much success trading soybeans or silver in the past, why try to continue to trade them in the future?

How much capital are you going to put into your trading accounts?

Something I have to add here, stay away from looking at percentage returns when evaluating performance statistics, such as percent return or drawdowns, on your personal account.

Concentrate instead of dollar amounts.

What is your dollar amount tolerance? My stomach turns at a specific dollar amount drawdown. Percentages vary too much according to how much money you keep in your account.

You might have a net worth of 1 million. Keeping 100,000 in your trading account and your situation will be entirely different than a person who has 5 million and keeps 100,000 in the trading account.

The person with the higher net worth will feel freer to use a different type of leverage. So think in terms of dollar amounts…how much are you willing to draw
down to?

How do you plan to enter, exit, and manage trades?

I like dividing my contract size into two units. Sometimes I go all in and then scale out in halves. Other times I put half on and look to add the other half. Some positions I keep half on as a core
and use the other unit as a scalping unit.

Whatever style you choose, it should be written down into your plan.

What is your plan to manage drawdowns?

You will have drawdowns. It is unavoidable. What is your plan to manage them? How will you evaluate when you need to take time off? Put down the plan in the business plan now.

What are your monthly goals?

Are you going to strive to make a certain number of trades each week or perhaps a certain number of SP points? Remember, these are guidelines by which to measure your progress.

Some months will be better than in other months. The end of the month is a good time to do a periodic review. Most businesses do this on a monthly or quarterly basis.

Include a daily routine in your overall business plan.

How are you going to evaluate your performance each day? Keep a notebook of the things you do RIGHT.

Pat yourself on the back for small moral victories, such as exiting a losing position swiftly. Note the small incremental improvements you make.

Create an office environment designed to facilitate performance.

Eliminate distractions and outside influences. Reduce glare and get a comfortable chair. Invest in good equipment. Invest in an excellent data feed.

A contigency plan for interuption from non-trading events

Include a provision that will keep you from trading if outside circumstances create unusual stress, such as health, divorce, or a major move.

You might as well just write a check out of your trading account and kiss it goodbye. This is a hard thing to recognize before it is too late. People LOSE money during times of 10 major stresses: death, taxes, divorce, moving, health…you get the point.

If a tennis player severely sprains his ankle, he cancels the match. Why do damage to your ratings? Why mar your statistical record with sub-optimal performance?

Record Keeping. Keep a record like your life depends on it

Rate yourself on your routine and structure and nightly homework. Do you do research or have a way of logging results? What type of research is included in your program or plan?

My problem is I stack too many projects up on back burner. I need to streamline this area for myself. Or, I get diverted doing research, go off on a tangent late at night and stay up way too
late. Then I am not in optimal condition the next day. My business plan includes bedtime. I promise myself to adhere to it.

Rewards! All work, no play makes Jack a dull boy.

You must have outside interests or hobbies to get your mind off the markets at the end of the day. You must treat yourself to something you really want.

If you spend money on yourself you will eliminate subconscious poverty thoughts. I am serious. Treat yourself like a million bucks and you will be worth it soon.

Maybe after a good week, you treat yourself to a massage or buy something you want. I already have something in mind that I will do for myself if I meet my goals next year. It is something that does not cost too much but that I could never justify spending money on because it might seem frivolous. But the money comes from my trading account so nothing is frivolous!

What plans do you have to continually improve yourself?

See yourself as a top-notch person, health-wise, performance-wise, and attitude-wise.

How do you keep advancing in life? You know the old saying, if you are not going forward, you are going backward. Educational pursuits such as books and study courses are important but don’t neglect spiritual pursuit, or outside projects…perhaps building your website, starting your trading network, writing your book on all the trails and tribulations of the business, or working with a charity.

Writing A Business Plan – Final Words

I do not need to emphasize the importance of having a business plan. This post is not a step-by-step guide on writing a business plan. The goal is to give you the key elements to include in your plan.

Trading is a long journey. It is not going to be easy. Having a plan to guide your through the ups and downs will certainly help.

I hope this post is useful to you.

Do you have any questions or comments? Feel free to drop me a line in the comment section. I am happy to help.