Candlestick patterns have little value without the right trend context. Hence, a popular trading setup uses candlestick patterns with a moving average. The moving average provides a simple way to find the trend context.
This review assumes a basic understanding of candlestick patterns. Look at the Encyclopedia of Candlestick Charts (Wiley Trading) by Thomas Bulkowski for a solid reference on candlestick patterns.
Despite their often mystical names like engulfing and shooting star, candlestick patterns are not magical. They are simply well-defined price action patterns. Focus on the price action: high, low, open and close. Forget the names.
In our trading examples, we will use a 20-period exponential moving average (EMA) to define the trend and support/resistance levels.
Trading Rules For Candlestick with Moving Average
Long Trading Setup
- A pullback down to the 20 EMA
- A bullish candlestick pattern overlapping with the 20 EMA
- Buy as price breaks above the high of the last bar of the candlestick pattern
Short Trading Setup
- A pullback up to the 20 EMA
- A bearish candlestick pattern overlapping with the 20 EMA
- Sell as price breaks below the low of the last bar of the candlestick pattern
Candlestick Patterns with Moving Average Trade Examples
Winning Trade – Bearish Engulfing
This is a candlestick chart of EUR/USD forex. We looked out for candlestick patterns with a moving average.
A trade setup came as a bearish engulfing candlestick pattern formed at the 20-period EMA. The next day was a strong bear trend bar. It triggered our sell order at the low of the pattern. This trade followed through quickly.
Look at the top of the chart. After a test of the previous trend high, prices reversed down with strong momentum.
The pullback upwards tested the 20-period EMA and the low of a prior trading range (the blue horizontal line). The bearish engulfing pattern showed strong rejection by these resistances. This trade had the potential to catch the beginning of a new downwards trend.
When trading candlestick patterns with a moving average, you can use the distance between the candlesticks and the EMA to judge the momentum. In this case, the large gap between the candlesticks and the EMA showed the bearish momentum.
Losing Trade – Bullish Harami
This is a daily chart of Marshall & Ilsley Corporation. We saw a bullish harami right on the 20-period EMA. The next day broke the high of the inside bar. We went long but the trade went against us.
A key candlestick principle is to wait for confirmation. Many traders wait for one more candlestick after the pattern for confirmation.
However, waiting for confirmation indiscriminately is not a good idea. This is why my trading rules are to enter upon break of the high or low of the pattern. Of course, for the weaker trading setups, waiting for confirmation is prudent.
Here, we saw clear downwards momentum. Prices also closed below the EMA with ease. Given such strong momentum downwards, it was wiser to wait for bullish confirmation.
The confirmation never came. Hence, an astute trader could have avoided this trade by demanding some signs of returning bulls.
Review – Trading Candlestick Patterns With A Moving Average
Candlestick patterns are well-defined pieces of price action with clear underlying market concepts. Beginners will find candlestick patterns useful for picking up price action.
Using candlestick patterns with a moving average helps to clarify the trend. It also helps us assess the candlestick patterns better. Hence, combining candlestick patterns with a moving average is a simple yet effective trading approach.
However, candlestick patterns are for clarifying price action.
Do not use them to force rigid interpretation on price bars, give them mystical names, and expect predictable results. Focus on the context, understand the nuances within each pattern, and be flexible when trading them.
For more information on trading candlestick patterns with a moving average, take a look at the following:
- An experienced trader shares how he trades using candlestick patterns with a moving average.
- Profitable Candlestick Trading: Pinpointing Market Opportunities to Maximize Profits (Wiley Trading) by Stephen Bigalow, a widely cited candlesticks expert.