8 Candlestick Trading Strategies for Forex

  • Looking for candlestick patterns is a great technique to locate trading opportunities in the market and get insight into the direction of price movements. Candlesticks visually represent the price and provide a complete overview of all relevant data. The key to success when trading using candlestick charts is establishing an entry point into the market based on high-probability patterns and then managing the trade according to a set of rules consistent with your money management philosophy.
  • Merchants have found many patterns that give high probability trading opportunities since Japanese rice traders invented the candlestick by including open, high, low, and closing prices. In addition, a wide variety of sizes and shapes may be used to create designs with candlesticks. The pin bars are an example of a candlestick pattern that only spans a single period, but there are other patterns that span many bars, such as the Three White Soldiers.
  • However, the highest victory rate in Forex is not available for all patterns. We have found eight of the most common and reliable candlestick patterns while trading Forex. Let’s examine the value of recognizing these trends and building a trading strategy around them.

The 8 Candlestick Trading Strategies

1: Pin Bar Reversal Patterns

Due to their propensity for producing high-probability price action trading setups, pin bars are the most successful candlestick forms to trade. This is because we have a pin bar when the price moves up or down within a single period, but the closing price is still inside the prior bar’s range.

8 Candlestick Trading Strategies for Forex

Figure 1: Pin Bar Trading Strategy

  • Figure 1 displays a bullish pin bar and a bearish pin bar. Pin bars are traded by anticipating a price breakout either above or below the bar’s high or low. You would then enter the market at that time.
  • If the next candlestick’s high is greater than the body of the pin bar, the setup has been triggered. If your order has been triggered, you can use the nearby support and resistance levels to calculate your take-profit. Short-term traders need only aim for a reward-to-risk ratio of 3:1 or whatever number they deem appropriate.
  • Pin bars, on the other hand, indicate a trend reversal when they form at the extreme high or low of a sustained trend. Therefore, trailing your open position using ATR or X-bar stop losses may be an excellent strategy to maximize your long-term profit.

2: Bullish and Bearish Engulfing Patterns

In the same way, pin bars suggest a reversal of the trend, and bullish and bearish engulfing candlestick patterns do the same thing. These chart patterns are more often referred to as a “bullish outside bar” (BUOB) or a “bearish outside bar” (BOOB) in the Western trading community. You can identify an outside bar by its extraordinary highs and higher lows than the preceding bar. In other words, a BEOB occurs when the closing price is lower than the opening price, and a BUOB occurs when the closing price is higher than the opening price.

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Figure 2: Bearish Outside Bar Triggered Downtrend

  • In Figure 2, a significant bearish candlestick has absorbed a smaller bullish candlestick that came before it. As the name implies, this is a bearish outside bar (BEOB). In this case, a sell-stop order set a few pips below the trough of the BEOB candlestick and aimed at the next pivot zone would have resulted in a profitable trade with an acceptable reward-to-risk ratio.
  • You can trade engulfing candlestick patterns in a range-bound market, but you should seek them at the peak and bottom of a trend for reversal indications. An engulfing candlestick often breaks above or below a range, making it a good candidate for a breakout trade.
  • Stop-loss orders should be large since engulfing candles are often much longer than pin bars. One solution is to use the high and low of the engulfing bar to draw Fibonacci retracements and place a stop order at the appropriate Fibonacci level.

3: Inside Bars For Reversals and Continuations

  • For the most part, candlestick trading tactics work well for either reversing trends or riding them out. But inner bars, like the proverbial “hidden treasures,” may indicate either direction depending on their placement on the chart. As the polar opposite of an enveloping bar, an inner bar is designed to keep patrons safely inside its confines. In both height and width, it is shorter than the preceding bar, and it falls inside its bounds.
  • Remember that to trade them, the asset’s price must first make a decisive move over or below the high or low of the preceding (longer) bar.
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Figure 3 illustrates how inside bars may signal both a reversal and the continuation of an existing trend.

  • Two smaller bearish bars formed within the high and low of the preceding large bar, as shown in Figure 3. These inside bars can be as few as one or as many as several, making little difference whether they are bullish or bearish. In this case, the inside bar pattern is valid because the smaller bars did not break through the high or low of the larger bar.
  • If you see the price making a new high above the previous high of the larger bar, also known as a “mother bar,” you have a good chance of making a profitable momentum trade. For example, a bullish trend began after the price in Figure 3 broke above the mother bar’s high.
  • However, finding such inside bar patterns during a strong trend can indicate the continuation of the trend. Therefore, a stop-loss order should be placed above or below the mother bar. Setting the stop loss aggressively above or below the range of inside bars can be a good strategy if your money management strategy calls for a minor stop loss. However, if you start out in trading, it’s best to stick to a safer strategy, like a fixed stop loss around the mother bar.

4: Doji Bars Signal Indecision

  • When the starting and closing prices are close to one another, we get a Doji. So, according to the canonical definition, the starting and closing prices must coincide. So you may still count on it being a Doji, even if the difference is just a pip or two.
  • Different Dojis exist depending on the direction of initial price movement before reversal. For instance, a star Doji is formed when the day’s high and low are at the same distance from the open and close. On the other hand, a gravestone or dragonfly Doji is identified by a price pattern in which the price moves up and down before settling back to its initial level. Bearish and bullish signs are shown in these two formations, which resemble the letter T and an inverted T.
  • A Doji pattern indicates market uncertainty. But the Doji bar’s location is equally important to think about. Breaking above a Doji that appears during a strong trend may indicate that the trend will continue.
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Figure 4 shows a Doji candlestick, which indicates indecision; nonetheless, you should focus on which direction the candlestick breaks.

Figure 4 depicts the formation of a Doji during an upswing, which indicates a brief pause in the market’s momentum. The uptrend, however, resumed as soon as the asset’s price moved above Doji’s high.

A buy-stop order set a few pips above the peak of the Doji Sar bar would have allowed you to enhance your long exposure or enter the market for the first time. However, with that said, a Doji bar’s diminutive size means traders may get away with a tight stop loss, increasing the potential gain while minimizing the danger.

5: Three Bar Reversal Patterns

  • Candlestick designs with three bars are the most straightforward to recognize. For example, three white soldiers indicate a bullish reversal, whereas three black crows indicate a bearish reversal.
  • Three consecutive bullish or bearish bars at the peak or bottom of a continuous trend are a reversal indication, as the name says.
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Figure 5 illustrates how the appearance of three white crows triggered a downward trend.

Figure 5 shows three bearish bars that appear rather good near the peak of an upswing. Remember that it’s okay if the first bearish bar’s high wasn’t the trend’s highest point. When three bearish bars appear at the peak of a bullish trend, this formation is known as the “Three Black Crows.”

Once the asset price dropped below the low of the lowest bearish bar, the downward trend continued. It’s normal for prices to retrace somewhat once they’ve broken the low. If you want to avoid a loss, place your stop order above the height of the tallest crow.

The Three White Soldiers’ bullish signal pattern follows the same rules.

6: Hanging Man Signals Bearish Reversal

  • If there is a significant price drop, but the market closes relatively close to where it opened, a hanging man candlestick pattern will appear, with a lengthy shadow that is often twice as long as the candle’s body. The Hanging Man pattern is similar to a bullish pin bar, but it often occurs near the conclusion of an upswing, sometimes with a gap. However, it’s OK if there isn’t any separation at all.
  • Always look for Hanging Man patterns as bearish signals, and if the price makes a new high after forming one, don’t place a bullish order. However, a pattern looks quite similar, appears at the bottom of a downtrend, and indicates bullishness in the market: a hammer.
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Figure 6: Hanging Man Triggers Bearish Trade

Figure 6 depicts the formation of a hanging man candlestick pattern, which, upon the subsequent breakdown of the bar’s bottom, sets off a negative trend that continues for the next several bars. Here, a stop-loss order placed above the Hanging Man’s top high point is warranted.

7: Rising and Falling Three Methods

  • It takes some practice to master the Three Methods of the Candlestick Trading Technique. For example, the rising three-wave pattern is deceptive because it consists of a vast bullish candlestick followed by three smaller bearish candlesticks. Contrarily, three minor bullish candlesticks are included in the falling three-technique pattern after a significant bearish candlestick has been generated.
  • A rising three-method pattern has formed when a vast bullish bar appears, followed by three smaller, bearish candlesticks that close above the bottom of the initial sizeable bullish bar—forming a fifth bullish candlestick that both opens and closes above the high of the first bullish candlestick are required to confirm the continuation of the bullish trend. A little daunting at first glance, but with the help of an example chart, I can make sense of it.
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Figure 7: Rising Three Method Trend Continuation Signal

Figure 7 depicts a massive bullish candlestick and three smaller bearish ones. Finally, to finish the rising three-candlestick pattern, the fifth bullish candlestick completely consumed the previous three bearish candlesticks and finished above the first candle’s high.

Wait for the fifth candlestick to close, and then join the trade with a market order if you want to trade this pattern successfully. The third bearish bar may be used as a stop loss by aggressive traders, while the first bullish candlestick may be used as a massive stop loss by more careful traders.

You may trade similarly on the other side for falling three-step methods.

8: Harami Cross As Reversal Signal

A bullish or bearish candlestick at the peak or bottom of its trend is followed by a Doji that stays inside the range of the preceding candlestick, creating a Harami Cross pattern. Conversely, a negative retracement is likely to occur if a bullish candlestick is followed by a Doji that rests within the high and low, like an inside bar.

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Figure 8: Harami Cross Signals Bearishness

Figure 8 shows a Harami cross developing at the peak of a bullish trend. Put a Sell Stop order in a few pips below the bottom of the bullish candlestick and wait for the asset’s price to break below that level.

The Bottom Line

Most of the time, all you have to do to trade using a strategy based on candlestick patterns is wait for the pattern to emerge and then set a stop entry order to buy or sell above or below the candlesticks. In this approach, your market entry should coincide with the confirmation of a deal.

While it would be simple to join the market using the candlestick tactics we outlined, properly putting them into practice would need careful capital management and timing of market exits.

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