How to Trade Candlestick Patterns with Trend Lines

Traders have formulated so many trading strategies. Most trading strategies are developed around price action without the use of any technical indicators.

And then you wonder how that is even possible, having trading strategies that do not incorporate technical indicators.

Yes, it is possible. Some of such price action strategies are those developed around candlestick patterns and trend lines.

Two key questions arise here. First, what candlestick patterns are, and second, what trend lines are.

Well, I will seek to answer both questions satisfactorily before we can talk about how you can trade a combination of the two.

Let us get at discussing each of the two now.

What are Candlestick Patterns?

We need to first establish what candlesticks are because it is candlesticks that form candlestick patterns.

So what are candlesticks?

A candlestick is a representation of an asset’s price during a given period.

You can choose the desired timeframe within which a candlestick will form.

After the end of that specified period, another candlestick will begin to form, and so on.

There are basically two candlestick types – bullish candlesticks and bearish candlesticks.

In a bullish candlestick, the closing price is higher than the opening price. In a bearish candlestick, however, the closing price is lower than the opening price.

Bullish candlesticks are usually of a different color from bearish candlesticks, say green for bullish and red for bearish.

Parts of a Candlestick.

A candlestick has two parts – a body and two tails or shadows. Note that the tails may not always be present in a candlestick.

Sometimes a candlestick will have two tails, one tail, or no tail at all.

The body represents the opening and closing prices. T

he ends of the two tails represent the highest and lowest prices within the period of the candlestick formation.

Here are the specifications;

• Bullish candlestick (Green) – The lower end of the body represents the opening price while the upper end the closing price.

The end of the upper tail represents the highest price while that of the lower tail represents the lowest price.

• Bearish candlestick (Red) – The upper end of the body represents the opening price while the lower end the closing price.

The end of the upper tail represents the highest price while that of the lower tail represents the lowest price.

Having said that, there are 3 basic features of a candlestick.

• The body – represents the opening and closing prices.
• The tails – show the highest and lowest prices during the specific period.
• The color – shows the direction of the price movement.

A green body shows a rising price while a red body shows a falling price.

Note that the colors will vary depending on the platform you are using to trade

Candlestick Patterns.

A candlestick pattern is a specific orientation of a single or a set of candlesticks.

Candlesticks form specific patterns which traders can recognize and utilize for profitable trading.

Some candlestick patterns will have a bullish connotation as others signify bearish price moves.

Other candlestick patterns will show market indecision and so warn traders from entering the markets.

Here are some of the most significant candlestick patterns with bullish connotations:

• Bullish engulfing – formed by a short bearish candlestick completely engulfed by a larger bullish candlestick.

The bullish candlestick must gap down to open below the close of the bearish candlestick, then close above the open of the same candlestick.

• Hammer – formed by one candlestick with a short body and a long lower tail.

The tail must be more than twice the height of the body.

• Inverse hammer – formed by one candlestick with a short body, a long upper tail, and very short or no lower tail.
• Three white soldiers – formed by three consecutive bullish candlesticks with small wicks.

From the second, each candlestick must open and close higher than the previous.

• Piercing line – formed by a long bearish candlestick followed by a long bullish candlestick.

The bullish candlestick must gap down to open below the close of the bearish candlestick, then close at or above the middle of the body of the bearish candlestick.

• Morning star – formed by a long bearish candlestick followed by a gap down then a short-bodied candlestick or a doji, a gap up then and a long bullish candlestick.

On the other hand, here are some of the most significant candlestick patterns with bearish connotations:

• Bearish engulfing – formed by a short bullish candlestick completely engulfed by a larger bearish candlestick.

The bearish candlestick must gap up to open above the close of the bullish candlestick, then close below the open of the same candlestick.

• Hanging man – formed by one candlestick with a short body and a long lower tail.

The tail must be more than twice the height of the body. Its difference with the hammer is that it occurs near the end of an uptrend.

• Shooting star – formed by one candlestick with a short body, a long upper tail, and very short or no lower tail.

Its difference with the inverse hammer is the uptrend.

• Three black crows – formed by three consecutive bearish candlesticks with small wicks.

From the second, each candlestick must open and close lower than the previous.

• Dark cloud cover – formed by a long bullish candlestick followed by a long bearish candlestick.

The bearish candlestick must gap up to open above the close of the bullish candlestick, then close at or below the middle of the body of the bullish candlestick.

• Evening star – formed by a long bullish candlestick followed by a gap up then a short-bodied candlestick or a doji, a gap down then a long bearish candlestick.

What are Trend Lines?

A trend line is a drawing tool used to draw significant price levels horizontally and diagonally on the price chart.

It is a technical analysis tool useful to traders who are fond of drawing.

Trend lines actually form the basis of channels, for they are the very tools used to draw channels of the price on the price chart or channels of the price representation on an oscillator window.

Channels and Trend Lines.

Trend lines are used to connect swing highs and swing lows of the price on the price chart to get channels.

Channels, in turn, give the general direction of the price and aid in making trading decisions.

If using trend lines, you join swing highs and swing lows of the price and get an upwardly slopping channel, then the general price direction is upward.

In this scenario, the most important trend line is the one joining the swing lows.

The price or its representation is meant to always obey such trend line and if it breaks it downwards, then that uptrend has weakened and may reverse downwards shortly.

On the other hand, if using trend lines, you join swing highs and swing lows of the price and get a downwardly slopping channel, then the general price direction is downward.

In this scenario, the most important trend line is the one joining the swing highs.

The price is meant to always obey such a trend line and if it breaks it upwards, then that downtrend has weakened and may reverse upwards soon.

There is also a possibility of joining swing highs and swing lows with trend lines to get a horizontal channel.

In such a situation, both the upper and lower trend lines are important.

The price is meant to reverse downwards at the upper trend line and upwards at the lower trend line.

Breaking any of those lines nullifies the price range a huge price move may follow thereafter, in the direction of the breakout.

Trend Lines Occurring Singly.

It is not cast on the stone that trend lines must be in pairs forming price channels.

You can have trend lines that occur singly without a corresponding line, giving the general impression of the trend of the market.

They also work perfectly well, just as those trend lines forming price channels would.

That said, do not kill yourself trying to find a complementary trend line to the one you already have to form a channel.

If no trend line fits to complement the one you already have run with the single trend line which defines the general market trend well.

As you resort to a single trend line, however, take note of this.

A single trend line showing a general uptrend should do so by slopping upwards after joining the major lows.

On the other hand, a single trend line showing a general downtrend should do so by sloping downwards after joining the major highs.

How to Trade Candlestick Patterns with Trend Lines.

Now that you understand what candlestick patterns and trend lines are, how about we now get to understand how the two can be combined together in a perfect trading strategy?

The next part of this post focuses on how to trade candlestick patterns with trend lines.

Without further ado, here are the simple steps on how to trade candlestick patterns with trend lines:

• Draw the Trend Line(s).
• Look for a Signal.
• Identify a Relevant Candlestick Pattern.
• Enter a Buy or Sell position.
• Adjust Stop Loss and Take Profit.

1. Drawing the Trend Line(s).

The first-ever step of this strategy is drawing the trend line or trend lines on the price chart. Here is how to go about it.

• Locate the major swing highs of the market.
• Join the highs using a trend line.
• Locate the major swing lows of the market.
• Join the lows using another trend line.

Done that?

Then note the direction in which the channel you get is sloping.

Is the channel sloping upwards, downwards, or horizontal?

Have you established the general market trend as shown by the channel?

You should also check if the two trend lines correspond to each other forming a perfect price channel.

If both trend lines forming your channel do correspond, then good for you. You can keep the channel and use both trend lines as we shall see later.

If they don’t, erase one and pick the one which supports the general market trend as established primarily by the price channel.

That is to means that if your channel was upwardly sloping, you will uphold the trend line joining the major lows and erase the imperfect trend line joining the highs.

On the other hand, if your channel was downwardly sloping, you will uphold the trend line joining the major highs and erase the imperfect one joining the lows.

What about channels that were horizontal?

Keep the trend line that appears to be in a perfectly straight horizontal line and erase the crooked one. You can use the horizontal line feature to confirm.

It is possible to have support and lack a nearby resistance and vice versa.

2. Looking for a Signal.

After drawing the trend lines or price channels, there were several potential outcomes which include:

• An upwardly sloping channel or an upwardly sloping single trend line.
• A downwardly sloping channel or a downwardly sloping single trend line.
• A horizontal channel or a horizontal single trend line at support.
• A horizontal channel or a horizontal single trend line at resistance.

With that in mind, then here are the possible bullish and bearish signals to expect:

• First Bullish Signal – when the price bounces off the lower limit of an upward sloping channel or off an upwardly sloping single trend line.
• Second Bullish Signal – when the price bounces off the lower limit of a horizontal channel or off a single trend line at support.
• Third Bullish Signal – when the price breaks above the upper limit of a downward sloping channel or above a downwardly sloping single trend line.
• Fourth Bullish Signal – when the price breaks above the upper limit of a horizontal channel or above a single trend line at resistance.
• First Bearish Signal – when the price bounces off the upper limit of a downward sloping channel or off a downwardly sloping single trend line.
• Second Bearish Signal – when the price bounces off the upper limit of a horizontal channel or off a single trend line at resistance.
• Third Bearish Signal – when the price breaks below the lower limit of an upward sloping channel or below an upwardly sloping single trend line.
• Fourth Bearish Signal – when the price breaks below the lower limit of a horizontal channel or below a single trend line at support.

Having any of the above signals is not enough to trade.

You must incorporate the aspect of the candlestick pattern as depicted in the next step.

3. Identifying a Relevant Candlestick Pattern.

It is in this step where the rubber meets the rod.

It is here where the application of both trend lines and candlestick patterns finds significance.

So how do you blend candlestick patterns and trend lines to pick your entries?

It is very simple.

For every bullish signal, you obtained in the previous step, you must lookout for a bullish candlestick pattern as an entry trigger.

Likewise, for every bearish signal obtained in the previous step, a bearish candlestick pattern must accompany it as an entry trigger.

Look out for the following bullish candlestick patterns when a bullish signal comes up:

• Bullish engulfing.
• The Hammer.
• Inverse Hammer.
• Three White Soldiers.
• Piercing Line.
• Morning Star.

On the other hand, look out for the following bearish candlestick patterns when a bearish signal comes up:

• Bearish engulfing.
• Hanging Man.
• Shooting Star.
• Three Black Crows.
• Dark Cloud Cover.
• Evening Star.

4. Entering a Buy or Sell position.

At this point, you have already established a signal and a relevant candlestick pattern is accompanying it.

Once the bullish candlestick pattern formation is complete and a bullish signal had just formed, enter a buy position.

On the flip side, once the bearish candlestick pattern formation competes and a bearish signal has just formed, enter a sell position.

5. Adjusting Stop Loss and Take Profit.

For buy positions, the Stop Loss order should be just below the trend line respected, or ideally below the lowest low of the bullish candlestick pattern.

For sell positions, the Stop Loss order should be just above the respected trend line, or ideally above the highest high of the bearish candlestick pattern.

Take Profit orders for all positions should respect a risk to reward ratio of at least 1:2.

You can ideally take profit at the trend line opposite entry if you are using a price channel.

Wrapping Up.

Trading candlestick patterns with trend lines has never been easier.

This post has just simplified the whole matter for you, and so all you have to do is to incorporate the ideas of the post in your trading. Begin today.

Happy Trading!