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TECHNICAL ANALYSIS

Trading Candlestick Patterns with Moving Averages

technical analysis, candlestick patterns, moving average strategy, moving averages, trading strategy

MOVING AVERAGES

Before we discuss about the strategy, let’s talk a little about Moving Averages. A widely used indicator in technical analysis that helps smooth out price action by filtering out the “noise” from random price fluctuations, a moving average (noted MA) is a trend following indicator, or also known as lagging indicator. It is one of the most known and used indicators among technical analysts and not only.

There are many types of moving averages, but the most used are 1) the simple moving average (SMA), which is actually the simple average of a security price (which could be open/high/low/close) over a defined number of time periods, and 2) the exponential moving average (EMA), which gives bigger weight to more recent prices. The most common applications of MAs are to identify the trend direction and to determine support and resistance levels. While MAs are useful enough on their own, they also form the basis for other indicators such as the Moving Average Convergence Divergence (MACD).

THE STRATEGY

Now that all the terms are clear let us talk a little bit about the trading strategy. The system is based on a moving average (it doesn’t matter if it is SMA, EMA, WEMA, etc), which has proved to act like a very good mobile support and resistance. I would suggest here to try some combinations using these period numbers: 7, 21, 30, 50, 100, and 200.

Once you have found a moving average that works well on a certain instrument (all instruments require fine tuning for MAs, meaning that a 200 EMA will not work as well on EURUSD and NZDUSD), you will just have to hunt for candlestick patterns which emerge around the moving average.

Let us take the following examples:

1. In the first example I have put a 200 periods EMA on the 60 minutes chart of the EUR/USD. The price has clearly broken the EMA and dropped to 1.3585. Here the demand grew for the Euro and pushed the price back to the EMA where we can see that a Shooting Star has been drawn. This is usually an important signal. Taking into consideration this setup a Short position should have been taken at the opening of the next candle. The Stop Loss should have been set above the Candlestick Pattern and the Take Profit somewhere near the demand area. Of course with good position management the profit could have been even bigger.

technical analysis, candlestick patterns, moving average strategy, moving averages, trading strategy

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