Before Homma developed candlestick charting, traders in his hometown of Sakata, Japan followed a set of rules and methods called Sakata’s Constitution. Homma later used a set of patterns in this constitution, called Sakata’s Five Methods, as the basis of his candlestick charting principles. Today, these patterns still help traders identify simple trends in the market.
Sakata’s Five Methods consist of five specific patterns: three mountains, three rivers, three gaps, three parallel lines, and three methods. What’s the significance of three? Japanese culture at the time believed three to be a significant, even divine number. Homma also believed that when traders found a promising trade, they should wait for three days. If the trade still looked good after three days, it would then be profitable.
As you read the description of these patterns, some may already sound familiar to you. Nonetheless, these candlestick formations can help you predict simple trends in the market.
The three mountains pattern shows three candlesticks moving up or down in a trend. Usually, this pattern indicates that the trend is about to end. If the middle candlestick is higher than the other two, the formation becomes a three Buddha formation or a head-and-shoulders pattern. Traders should plan for the market to reverse its direction.
The three river method also indicates a reversal pattern. This pattern looks different depending on if the reversal is bullish or bearish. The bearish version of this pattern, called a three river evening star, shows a long bullish candlestick, a short, bullish candlestick (also called an island or a star), and a bearish candlestick where the low is below the midpoint of the candlestick body on the first day. The bullish version, called a three river morning star, shows a long bearish candlestick, a short, bearish candlestick, and a bullish candlestick where the low is below the midpoint of the candlestick body on the first day.
The three gaps pattern appears when the trading is high. A gap happens when the opening price moves significantly higher or lower than the close of the last candlestick and creates an empty spot on the chart. The three gaps pattern usually means a trend is over and is about to change. After the third gap of this pattern appears and the market reverses, the market moves enough to close the length of the second gap.
The three parallel candlestick pattern refers to three consecutive candlesticks that are going the same way and have a similar height. This means the ongoing direction is expected to continue and traders should plan accordingly. When the three candlesticks are bullish, the formation is known as the three soldiers; when bearish, the pattern is called the three crows.
In the figure above, you can see a bearish rising three: a bearish candlestick is followed by three bullish candlesticks and then another bearish candlestick. This pattern usually means there is inactivity in the market and that a lot of tight trading is happening.
While candlestick charting may seem like a lot to learn, don’t worry. As you read candlestick charts, these common patterns will become more familiar to you. Over time, you’ll learn about other patterns and combinations of patterns that you can use to determine the state of the market, anticipate its possible direction, and identify market patterns.
One of the best ways to analyze candlestick charts and test your knowledge of patterns is by opening a CFD practice trading account. If you already have a live account with a CFD provider, you can also view candlestick charting on historical data.