Skip to main content
EN
Menu

Learn the stock market › Candlesticks and patterns › Lesson 6 of 6

Do chart patterns work?

Short answerOf 38 comparisons between a pattern and an ordinary day for the same company, 0 fell outside the range chance tends to give, and with that many tests you expect about 2 by pure chance. The same rules found 58 head and shoulders in the prices of the 20 largest US companies and 59 when each company's days were shuffled into random order.

Every pattern in one table

Here are the nine candlestick patterns that point one way, a week later, and the eight chart patterns, a month later. Held means the price went the way the pattern is said to point. Ordinary period is the same thing counted from every day of the same company. The rules are in lessons 2, 3, 4 and 5.

PatternTimesHeldOrdinary period
Hammer, 1 wk1,58654.9%56.1%
Hanging man, 1 wk2,27543.2%43.7%
Shooting star, 1 wk1,83445.4%43.8%
Bullish engulfing, 1 wk1,07957.3%56.0%
Bearish engulfing, 1 wk1,91643.6%43.8%
Morning star, 1 wk42459.0%56.2%
Evening star, 1 wk51643.8%43.6%
Three white soldiers, 1 wk85856.6%56.2%
Three black crows, 1 wk59143.8%43.9%
Head and shoulders, 1 mo5836.2%38.8%
Inverse head and shoulders, 1 mo6971.0%61.6%
Double top, 1 mo20040.5%38.9%
Double bottom, 1 mo31066.5%61.0%
Triangle, break up, 1 mo46763.6%60.9%
Triangle, break down, 1 mo32738.2%39.1%
Bull flag, 1 mo31655.7%59.9%
Bear flag, 1 mo16440.9%40.8%

How many hits does chance give?

Each comparison has a range that chance tends to give, worked out so that differences between years are taken into account. A pattern that means nothing still lands outside it in about one case in twenty.

The course has 38 such comparisons: the candlestick patterns after a week and a month, the chart patterns after one and three months, and how often the targets were reached. None of them fell outside the range.

Patterns in shuffled prices

We took each company's own daily moves since 2010 and put them in random order. The price starts and ends at the same level and every day is a real day, but the order is random. In such prices no pattern can mean anything. Then we searched them with the same rules.

PatternReal pricesSame days shuffled
Head and shoulders5859
Inverse head and shoulders7171
Double top208284
Double bottom328371
Triangle, break up484452
Triangle, break down345368
Bull flag346384
Bear flag183239

The counts differ for some patterns, but every pattern also turns up in prices whose order is chance.

Why do so many people trust the patterns?

The eye finds shapes in random data, and a pattern that worked becomes a memory and an example in a book, while the ones that didn't are forgotten. A chart drawn after the fact also shows only the peaks that turned out to be peaks. That is why you need a rule written before the test and a comparison with an ordinary day. The same kind of test on RSI, moving averages and MACD is in the study on technical analysis.

The research doesn't fully agree. One study of candlestick patterns in large US stocks found they created no value. Another study of chart patterns in US stocks from 1962 to 1996, using a computer program to find the shapes, found that some of them gave some extra information. Both are listed under Sources.

What it means

The test has limits. It covers today's 20 largest companies, which have all done well, and the rules are ours. Other limits find other patterns. But anyone using a pattern should be able to say which rule applies and how often it has held against an ordinary day.

Test yourself

A chart shows a clear head and shoulders. What does the shuffled-price test teach you?

Sources