Trend lines and candlestick patterns together work best for trend following and gives best entry with high probability trading setup. Also to mention that when analyzed trend lines and candlestick patterns together they can be very powerful to spot reversals and continuations which in turn can give traders a distinct advantage over other lagging indicators.
Table of Contents
- What is a trend?
- How to spot an Uptrend or Downtrend
- Trend lines :
- The Top 5 Candlestick Patterns for Trend Trading:
- How to use Trend lines and Candlestick Patterns for Risk Management:
- Using candlestick patterns to spot a trend reversal:
- Trend Following Candlestick Strategy
- Best Indicator to Identify Trends
- Trend Trading with Candlestick Patterns and Moving Average
- Using Trend lines and Candlestick Patterns to avoid Fake Breakouts
This blog covers everything you need to know about how candlestick patterns with trend lines can work together, how to spot a trend reversal, how to use trend lines and candlestick patterns for risk management, Trend following candlestick strategy and how to use trend lines and candlestick patterns together to avoid fake out entries.
What is a trend?
In the financial market, a trend is a broad direction in which a market’s price moves. Price action that emphasizes swing lows and swing highs for uptrends and downtrends help traders to identify trend in the market.
When a market is moving upward, it is considered to be in an uptrend.
The market is in a downtrend when the price direction moves downward.
No price moves in a straight line. Prices frequently fluctuate in either direction.
If the price is unable to make new highs and lows, the market is said to be range bound or sideways. In this situation, the market creates equal highs and equal lows.
How to spot an Uptrend or Downtrend
One of the easiest ways to spot an uptrend is if the market is higher than its prior high and without going below its previous low.
This is made up of ‘HIgher Highs’ and ‘Higher Lows’.
The uptrend is regarded as intact as long as the price continues making these higher highs and higher lows.
To make an uptrend more recognizable, use any 2 swing lows (higher lows) and connect them by using trendlines and extending the line further.
On the other hand, a downtrend remains in motion if the market is lower than it’s previous low and not rising beyond its prior high. This is distinguished by ‘Lower Highs’ and ‘Lower Lows’.
The price will continue to form lower highs and lower lows as long as the downtrend is there.
A downtrend can be recognized by connecting 2 swing highs (lower highs) and extending the line further.
Trend lines :
A trader can use trendlines for trend trading in association with other technical tools to boost the chance of making a profitable trade in both uptrend and downtrend conditions.
Trendline levels are used by technical analysts to search for price activity that may help anticipate future market behavior and to set up entry and exit points for trades.
Candlestick patterns are an excellent trend analysis approach that many traders employ in conjunction with trendlines.
Candlesticks patterns, together with trendlines, can assist a trader in identifying entry and exit signals for high-probability trade setups.
A trader can utilize single or multiple candlestick patterns to identify and evaluate if a trend is reversing or continuing. For example, the appearance of a hammer candlestick pattern with trend lines implies that the uptrend will continue. Likewise, if a bearish engulfing candle forms on a downtrend level, a bearish continuation movement is anticipated.
In this chart, after drawing a trendline and extending it further, the price tested this trend line the third time and formed a bullish engulfing candlestick pattern, signaling a continuation movement of a prevailing trend. The price moved in favor, and the trend continued.
The Top 5 Candlestick Patterns for Trend Trading:
These top 5 candlestick patterns with trend lines, are often used by traders, to implement appropriate entry points:
How to use Trend lines and Candlestick Patterns for Risk Management:
Risk management is the one factor that distinguishes a smart trader from a gambler.
Knowing your risk is crucial whenever you make an entry into the markets.
It would be difficult for traders to survive in an uncertain market without risk management.
By studying trend lines and candlestick patterns together, a trader can determine the risk levels to limit losses if the market move against the favor.
In the chart below, a hammer candlestick is formed at the trendline level, this bullish signal was confirmed by the next bullish candlestick (Marubozu). To minimize risk, a stop loss level was set up below the wick of the hammer candlestick. Exhaustion of buyers dominated the sellers to reverse the price and a downtrend occurred. Furthermore, the trade was closed with a loss, but it could’ve been more disastrous if a stop loss wouldn’t be placed.
Using candlestick patterns to spot a trend reversal:
A trader would identify possible reversal points by aligning trend lines and candlestick patterns and wait for the price to break through. These reversal points serve as a leading indicator, indicating the impending emergence of a new trend.
For bullish trend reversal, wait for the price to break out of the downtrend line and simultaneously form a reversal candlestick pattern. In this example, a bullish engulfing candlestick broke through the downtrend line and confirmed a bullish reversal movement.
In case of a bearish trend reversal, wait for the price to breach the uptrend line and simultaneously produce a reversal candlestick pattern for the downtrend to form. This chart depicts a bearish reversal candlestick pattern near the trendline. A bearish reversal movement was confirmed by a breakout.
Trend Following Candlestick Strategy
After drawing a reliable trendline, wait for the price action to form a candlestick pattern that indicates a possible continuation signal. By doing this, you would protect yourself from the market whipsaws that usually take place close to trend line levels.
In a bullish market structure, a trend may be seen continuing if the price fails to break the uptrend line and forms some sort of candlestick pattern that indicates bullish dominance in the market. In the chart below, a bullish engulfing candlestick pattern was formed after testing the trendline. A stop loss was set below the engulfing pattern and trendline. Price then continued the trend thereafter.
This type of combination of trend lines and candlestick patterns increases the probability of profit .
Similarly, in a bearish market structure, the formation of a candlestick pattern after testing the downtrend line might serve as a possible downtrend indicator.
By looking at this chart, the market was down trending. After testing the trendline level, the exhaustion of buyers is indicated by the candlesticks with small bodies. A bearish engulfing candlestick pattern eventually formed and continued the existing trend.
Best Indicator to Identify Trends
There are thousands of indicators that traders use to identify trend continuation or reversals in different time periods. One of the most popular indicators, a trader can use on a candlestick chart is ‘Moving Average’.
Moving averages, which are lagging indicators, can be used in place of trendlines. Moving average updates the average price to level out pricing data. Long-term trends can be detected using the longer period Moving Average Indicator. A few examples include 50, 100, and 200. Additionally, a shorter period of Moving Average Indicators, such as 9, 15, and 25, helps for detecting short-term trends.
When the price rises above the Moving Average Indicator, it signals that the market is in an uptrend. Similarly, if the price falls below the moving average, the market is in a downtrend. Here’s an example of 200 periods Moving Average:
Trend Trading with Candlestick Patterns and Moving Average
Using Moving Average to indicate direction of trend lines and Candlestick Patterns to determine entry points results in a high probability entry setup that allows traders to make effective trading decisions in the long run. Moving Average may be used as a trend indicator as well as dynamic support and resistance tool. Before entering a trade, a trader should wait for a Candlestick pattern to form whenever the price tests the Moving Average Indicator line.
The 200-day moving average in the example below shows the general trend. When the price is above the moving average, the overall trend is upward. Similarly, the overall trend is downward when the price is below the moving average.
When the price is near the 200- day moving average and forms the candlestick patterns we’ve discussed before, a trader can initiate a buy position. A stop-loss level should be placed below the wick or moving average to avoid wick manipulation. The long-length moving average serves as a filter in this manner, assisting the trader in trading in line with the general trend.
Using Trend lines and Candlestick Patterns to avoid Fake Breakouts
To be quite honest, there isn’t a clear solution to this. Fakeouts happen frequently because we conduct business in markets where there is a lot of envy and unexpected manipulation. There is no assurance that using a variety of technical strategies at once will always work. By admitting that no one can control the markets and that mistakes are inevitable in trading, traders need to recognize fake outs and concentrate on risk management. To reduce vulnerability to fake outs, always look for the candlesticks and other technical tools to form a complete pattern at critical levels (trendlines) before placing a trade, and decide how much risk you can afford to bear. For example, if the price is approaching the trendline level, wait for the price action to generate some good entry indications before deciding what to do next.
[Suggested Reading : Double Bottom Pattern Trading strategy]
- The trend is your friend. By analyzing trend lines and candlestick patterns chart, it would be easier for a trader to understand the market structure.
- Trendlines are essential tools to determine trend direction. The trick is to correctly draw them by connecting two or more price points and then extending them further.
- A chart with a string of higher lows and higher highs is considered to be an uptrend market.
- Lower highs and lower lows define a downtrend market.
- Together with price action and other technical indicators, trendlines assist in determining whether a trend will continue or reverse.
- One of the simplest ways to understand continuation or reversal signals is through the combination of the trend lines and candlestick patterns.
- Trend lines and candlestick patterns are both reliable indicators for locating potential entry and exit opportunities.
- A moving average can be used as a substitute for trend lines. A trader might be able to identify advantageous entry points into the market by combining candlestick patterns with moving average levels.
- The best way to use trend lines and candlestick patterns together is by analyzing trend direction and then spotting opportunities with the help of candlestick patterns.
Author is Senior Technical Analyst
At Bulls Arena Trading