An Analysis of Prediction Power of Various Candlestick Patterns in Foreign Exchange Market

Abstract

The Foreign Exchange Market is where one currency is exchanged for another.In the 18th century, the Japanese developed an approach to technical analysis that traced and predicted the prices of rice contracts.There are some ways to classification of candlesticks. From one perspective they can be divided into two types of ‘Reversal Patterns', and ‘Continuation Patterns'.In this paper nine different reversal candlestick patters are analyzed. They include hammer, hanging man, doji gravestone, doji dragonfly, doji long-lagged, bearish and bullish engulfing, piercing pattern, and dark cloud cover. It is analyzed whether various candlestick patterns can predict candles and trends in Foreign Exchange Market. The first group of minor hypotheses include whether or not a candle with an inverted color proceed by these patterns. The second group analyze whether or not the profit of trading after various patterns is significantly profitable. I considered the first, second, and the third candles as different possible points for finishing the trades. These three different points have different results, hence I've categorized them in three various scenarios and discussed about them separately. One of the most important sign of power of a specific pattern is when the first next candle be a confirmation of trend changing. In this part only the confirmed cases are analyzed in two different scenarios. At the end on the basis of minor hypotheses, it is concluded that there is not any evidence that we can say “various candlestick patterns predict candles and trends in Foreign Exchange Market effectively". Although the success rates of correct prediction of the next candle after a confirmed pattern is almost insignificant in all cases, but the profit of trading after this confirmation can be significant. We can conclude that a confirmed pattern could be profitable in all mentioned patterns.