Candlestick patterns, particularly the bullish harami, offer visual cues that help traders interpret market sentiment. When combined with other technical indicators, these patterns can provide a robust framework for making trading decisions.
This article delves into the bullish harami candlestick pattern—its definition, identification criteria, and practical application through backtesting on the S&P 500. By the end, you’ll understand its profitability and how to incorporate it into your trading strategy.
What Is the Bullish Harami?
Bullish harami is a two-candlestick pattern that often signals possible change in downtrend. There are four variations of bullish harami. Here is how it looks:
First Candle: It’s a big bearish candle with a long red body, which means strong selling pressure.
Second Candle: A smaller candlestick that is usually a doji completely inside the body of the first candle. Doji represents indecision in the market given that the opening and closing prices are almost identical.
This pattern indicates that although the sellers dominated the initial stages, buyers could be getting in and reversing the trend lower.
How to Identify a Bullish Harami
In identifying a bullish harami, follow the steps below:
Downtrend: The pattern appears in a long downtrend.
Big Bearish Candle: The first candle is big with a red body, indicating heavy selling.
Small Bullish Candle: The second candle is small, and all of its body lies within the range of the first candle.
What Does the Bullish Harami Signal?
The bullish harami signals that there may be a reversal of the existing downtrend. Here’s the psychology behind it:
This is a large bearish candle. It means sellers are in control.
This is a small bullish candle or doji. It is an indication of indecision. Selling pressure is weakening, and buyers might be taking over.
It looks good, but a bullish harami alone cannot be used. Let’s see what increases its credibility:
Confirmation
Check if there is a follow-through move in the next candle where it closes higher to confirm the bullish sentiment.
False Signals
As with any technical indicator, the bullish harami is prone to false signals. Its reliability depends on the market conditions and context.
Integration with Other Indicators
Apply the bullish harami together with other technical indicators such as the Relative Strength Index (RSI) or Moving Averages for a more in-depth analysis.
Testing the Bullish Harami with the S&P 500
To determine whether the bullish harami is profitable, we backtested on these trading rules:
Pattern Formation: Identify a bullish harami.
RSI Filter: The 5-day RSI should be below 40 to validate the downtrend.
Entry and Exit: The trade is taken at the close of the pattern formation day and held for a certain number of trading days.
Average Gain: A backtest between 1993 to date with a holding period of 10 trading days results in an average gain of about 0.95% per trade, almost double the value of a random 10-day period.
Win Rate: The win rate ranged from 55% to 70% and had a dependency on holding periods. Longer holding periods resulted in higher win rates since the market tends to be biased upward over time.
Equity Curve: The equity curve had been showing a steady profit and not an upward straight line; therefore, it is a good strategy.
Critical Points for Traders
Context: There should be the occurrence of bullish harami in a true downtrend; otherwise, there is a loss of accuracy.
Follow-through Action is Critical: A trade is to be initiated only after the follow-through action.
Use with Other Indicators: This bullish harami can be used along with other indicators that will confirm the trading decision.
Backtesting is Important: Always test patterns on historical data before using them live.
The bullish harami is a visual way to spot the potential reversal within a downtrend. Though profitability in the S&P 500 backtest has been moderate, its reliability comes in with combining tools such as RSI and confirmation signals. Anything done well as a strategy always comes down to good analysis, disciplined execution, and ongoing learning.
It adds the bullish harami to your toolbox. You are making better decisions. And maybe improving the results. Leave your comments, experiences, with the bullish harami in the comment box below and also let us know which other candlestick patterns you would want us to analyze in the future!