The limitations of candlestick patterns in Forex

The quick answer is both "Yes" and "No".

Candlestick charting was first developed by Japanese rice traders and can be traced back several hundred years in the 18th century. According to Steve Nison, candlestick charting first appeared sometime after 1850. Much of the credit for candlestick development and charting goes to a legendary rice trader named Homma from the town of Sakata. It is likely that his original ideas were modified and refined over many years of trading eventually resulting in the system of candlestick charting that is used today.

In general Candlestick charting developed in the futures and stock markets and thus many of the patterns or techniques are suited more to these markets. Many still claim that Candlestick charting can be applied to the Forex market but there are limitations when the technique is used in Forex charts.

Why is this the case?

Well, the most obvious difference between futures and stock markets compared to the cash Forex market is the fact that the former two are session based and only trade for specific time periods during the day. The cash Forex market on the other hand is a 24 hour market and runs for just over 5 days beginning in New Zealand on Sunday evening and runs through to New York close on Friday.

The impact of this difference has a marked impact on the range of Candlestick patterns that can be applied to the Forex market. A large number of Candlestick patterns are based on the relationship of the prior bar's closing price and the new bar's opening price. In the futures and stock market these are frequently totally different as prices gap over a closing period in particular. It is even possible for these markets to see a day's range gap up higher on one day and then gap down lower the next to leave no overlap of the bars.

This just does not happen in the Forex market. The most that does occur is that Monday's open is different from Friday's close and can cause a gap. It doesn't occur that frequently though.

From that perspective it will mean that many Candlestick patterns just simply do not occur in Forex.

So what are the patterns that can be seen in Forex?

A simple response is "all those patterns that are not based on prices gapping."

A list of these are:

Reversal Patterns:

• Hammer & Hanging Man
• Bullish & Bearish Engulfing
• Bullish & Bearish Harami
• Bullish & Bearish Harami Cross
• Inverted Hammer & Shooting Star
• Three White Soldiers & Three Black Crows
• Advance Block
• Three Inside Up and Three Inside Down
• Three Stars in the South
• Stick Sandwich

Continuation Patterns:

• Rising Three Methods & Falling Three Methods
• Bullish & Bearish Three Line Strike

Ian Copsey
Global Forex Trading
http://www.gftforex.com