Forex - Forex Trading - Currency Trading
  • Forex Brokers
    • Compare Forex Brokers
    • ECN/STP Forex Brokers
    • STP Forex Brokers
    • DMA/STP Forex Brokers
    • PAMM Forex Brokers
    • Metatrader 4 Forex Brokers
    • Metatrader 4 ECN Forex Brokers
    • Metatrader 5 Forex Brokers
    • Brokers With Free Forex Signals
    • Social Trading Forex Brokers
    • Bitcoin Brokers
    • Binary Options Brokers
    • NFA / CFTC US Forex Brokers
    • FSA UK Forex Brokers
    • Micro & Mini Forex Brokers
    • Forex Brokers For Scalping
    • Forex Brokers For Hedging
    • High Leverage Forex Brokers
    • Brokers With FX Managed Accounts
    • Forex Brokers With Free VPS
    • Gold,Silver & Oil Forex Brokers
    • Forex Brokers With Segregated Accounts
    • Brokers With Forex Demo Accounts
    • Best Forex Broker Bonuses
    • Forex Broker News
  •  
  • University
    • Online Forex Trading Course
    • Complete Forex Video Course
    • Forex Trading Tutorials
    • Learn How To Trade Currency Pairs
    • Candlestick Video Course
    • Forex Technical Indicators
    • Forex Chart Patterns
    • Forex Trading Tips
    • Metatrader 4 Tutorials
    • Metatrader 5 Tutorials
    • Free Trading Courses
    • Forex eBooks Collection
    • Forex Freebies
    • Forex Dictionary 
    • Forex Downloads
  •  
  • Trading Strategies & Systems
    • Simple Trading Strategies
    • Forex Breakout Trading Strategies
    • Price Action Forex Strategies
    • Elliott Wave Forex Strategies
    • Fibonacci Strategies
    • Fundamental Strategies
    • Trend Following Metatrader 4 Systems
    • Forex Scalping Metatrader 4 Systems
  •  
  • Articles
    • Technical Analysis
    • Forex Systems & Strategies
    • General Forex Knowledge
    • Forex Money Management
    • Trading Psychology
    • General Trading
    • Forex Trader Interviews
  • Tutorials
    • Trading Tutorials
    • Metatrader 4 Tutorials
  •  
  • MT4/5 Downloads
    • Metatrader 4 Indicators
    • Metatrader 5 Indicators
    • Metatrader 4 Expert Advisors
    • Metatrader 4 Systems
  •  
  • Products
    • FREE Forex Analyzer PRO
    • eToro Social Trading
    • Automated Forex Trading (ZuluTrade)
  •  
  • Charts
    • Real-Time Forex Charts
    • Real-Time Forex Rates
    • EUR/USD Forex Charts
    • GBP/USD Forex Charts
    • USD/CHF Forex Charts
    • USD/JPY Forex Charts
    • USD/CAD Forex Charts
    • AUD/USD Forex Charts
    • NZD/USD Forex Charts
    • EUR/JPY Forex Charts
    • GBP/JPY Forex Charts
    • EUR/GBP Forex Charts
    • EUR/AUD Forex Charts
    • EUR/CAD Forex Charts
    • AUD/JPY Forex Charts
    • CHF/JPY Forex Charts
    • EUR/CHF Forex Charts
    • GBP/CHF Forex Charts
    • USD/SEK Forex Charts
    • Gold (XAU/USD) Charts
    • WTI Crude Oil Charts
    • Silver (XAG/USD) Charts
  •  
  • Tools
    • Correlation Charts
    • Relative Strength Index
    • FX Performance Charts
    • Economic Calendar
    • Pivot Point Calculator
    • Forex Historical Data
    • Currency Converter
    • PIP Income Calculator
    • PIP Value Calculator
    • Risk Calculator
    • Fibonacci Calculator
    • Forex Income Calculator
    • Forex Risk Calculator
    • Banks Interest Rates
    • Movers and Shakers
    • Find A Forex Job
    • Forex Daily High/Low
    • World Clocks
  •  
  • $30 FREE
  •  
Bookmark and Share Print This Page   | Home > FX Technical Analysis Articles

How Profitable Are Candlestick Strategies in Currency Trading?

Written by David R.

Some of the most popular trading strategies in forex markets involve the use of Japanese Candlestick charts. Given a specific pattern in candlestick formations, traders look to buy and sell currencies in anticipation of reversal or continuations in price. Yet testing the profitability of such concepts is easier said than done. Given that many of these formations are inherently qualitative in nature, it is difficult to develop a reliable quantitative approach with which to test the viability of such strategies. That being said, we will attempt to quantitatively identify specific candlestick patterns and backtest the profitability of trading on such candlestick signals. The first ones that we will analyze are morning star and evening star formations.

Candlestick Formations: Which do we choose?

Given a great number of different candlestick formations, it would be nearly impossible to gauge the overall profitability of all candlestick strategies in a single study. Instead, we will focus on specific reversal signals that we believe have intuitive value as it relates to market sentiment. In this particular case we will look at both the Morning Star and Evening Star formations as buy-and-sell signals.

A Morning Star formation is a bullish reversal signal for an overall downtrend. Given fairly consistent losses, we see a strongly negative full-bodied first candle. The second candle opens at or below the previous close, trading within a relatively narrow range with the high staying below the midpoint of the first candle. The third candle is strongly positive and closes above the midpoint of the first candle. This tells us that bearish sentiment is unable to push price below previous lows, and risks remain for a reversal in price trends.

The Evening Star is effectively the opposite of a Morning Star, as price starts in an uptrend and the first candle is strongly positive. The second candle opens above or at the previous close, trading within a fairly narrow range and with its low above the previous bar's midpoint. The third candle is strongly negative and closes below the first candle's midpoint. This gives warning that bulls are unable to push price to new heights, and a strongly bearish candle hints at further downside potential through subsequent trade.

Backtesting our Candlestick Formations

Using TradeStation's EasyLanguage, we translate our Candlestick rules into quantitative code in order to test their performance on a historical basis. In doing so, we can easily test our concepts across the spectrum of currencies and time frames. We take special care in not adding arbitrary elements to our code that may lead us to over-optimize our results, as our aim is to judge the raw profitability of the simple candlestick formation.

In terms of actual trading rules, we tell our strategy to buy a standard lot of the given currency pair when a Morning Star formation materializes and short sell the currency on an Evening Star. Our initial results do not include stop-loss orders or profit limits. Instead, gains and losses are realized when positioning flips on the subsequent Morning or Evening Star formations. Trading begins on the inception of the euro (12/31/99) and ends at publication date.



Initial Backtesting Results: Could we Improve Upon our Raw Candlestick Strategy?

Our initial backtest shows that our simple strategy remains modestly profitable across major currency pairs. Yet with sizeable Max Drawdowns, it remains clear that our strategy may do well with slightly improved risk management. Indeed, it may be important to take a closer look at individual exit and entry rules and their efficiency in capturing strong risk-adjusted returns.

Using TradeStation, we are able to quickly assess maximum profit and loss potential across trades with several functions. Of particular interest in this case is to measure each individual trade's maximum downward move before turning profitable. For simplicity's sake, we will look at EURUSD trades. The chart below gives us an accurate depiction of how risk/reward on overall trades.



The chart above shows us an interesting pattern in our candlestick-based trades. Namely, our most profitable trades tend to have very little negative incursion. In plainer terms, our best trades are those that are strongly positive from the onset and show very little downward extension. At the same time, some of our most negative trades show very little profit potential from a buy-and-hold perspective. What this tells us is that our strategy would likely benefit from a simple stop-loss measure that protects us from large losses yet does not keep us from making a profit on our more successful trades.

In this particular case we see that six out of ten trades that draw down beyond $2,000 turn out to be losers, while only one of nine that drawdown less than this amount end as net losses. This suggests that adding a stop loss to our strategy can dramatically improve our overall profitability.



The table above is clear evidence of this point, as our overall rate of return improves substantially if we limit or maximum loss to a total of $1,000 per given trade. Looking at our results, we see that our percentage of profitable trades drops dramatically when we set a stiff profit target on our trades. In fact, of 37 total trades, 24 produce a loss when we set our stop to $1,000. Yet the amount in profits we collect on each winner far surpasses the relatively modest loss on each loser. It seems as though our Morning Star - Evening Star candlestick strategy works best with tight stop losses and looser profit targets. The next logical question becomes whether we can improve our strategy with a fixed profit target.



The chart above shows us the exact opposite of our Maximum Adverse Excursion chart, whereby we can judge the efficiency of our profit-taking techniques on our trading strategy. The solid black line represents a 1:1 Maximum Favorable Excursion to trading profit line. In other words, trades closed at the line represent instances in which we have captured the maximum possible profit in a particular trading opportunity. Of course, we all know that this is a near-impossibility to achieve on a regular basis. Instead we look to see if there are any particularly extreme cases in which a set take-profit would have dramatically improved our profitability.



Again we see interesting results when we modify money management rules in our trading strategy. Our profitability improves and our overall rate of return rises when we set a fixed profit target of $12,000 per trade. Though the percentage of trades that are profitable drops to a mere 36%, it is clear that a reward to risk ratio of $12,000 to $1,000 offers very attractive risk-adjusted returns. Below we see the actual equity curve of our trading strategy and final conclusions on the profitability of our Morning Star - Evening Star candlestick strategy.

Final Conclusion and Caveats

Our attractive equity curve suggests that our candlestick strategy has been profitable in the EURUSD from inception to present. The raw results - with no set money management rules - were slightly less profitable, and tell us several interesting things about the nature of our candlestick strategy. We saw that profitability improved dramatically when we cut losses short and let our winners run significantly longer. This tells us that our candlestick signals are either "wrong" in their reversal signals and not worth holding, or they are "correct" and give us ample opportunity to take profits on a turn in trend. It is undeniable that this strategy does indeed provide many false trading signals. Yet we see that proper management rules allow us to capture solid profits and limit our downside on these declines. Combined with other trading techniques and more discretionary strategies, we would argue that these candlestick formations increase our overall trading profitability.


You Might Also Like:

  • Understanding Swing trading with Fibonacci Grid ...
  • Forex Stop Loss? I Don't Want To Use It...
  • Trading the Nonfarm Payrolls In Forex...
  • Bollinger Band Width And Trading Ranges...
  • Do Hammer and Shooting Star Candlestick Formations Work in Forex?...
  • How Profitable Are Candlestick Strategies in Currency Trading?...
  • Using Relative Strength to Trigger a Trade...
  • Stop Placement with Average True Range (ATR)...
  • ATR (Average True Range): Reading Forex Volatility...

INTERESTING FOREX SITES
Free Forex Strategies & Systems
A collection of forex systems, indicators and strategies. 100% Free Download.
Download Free Top Rated Metatrader 4/5 Indicators & Forex Robots
Download top rated MT4/MT5 forex indicators and expert advisors.
100 Forex Trading Strategies
Each forex strategy includes the buy and sell rules, and a free download link!
Get Forex Analyzer PRO Forex System
Start trading with one of the best fx systems for profitable forex trading!

Back to technical analysis articles

Find Us On Facebook

Best Forex Trading Software

Holo Eagle Forex System

Morpheus Forex trading System

Fibonacci Forex Scalper System


Home | Forex Newsletter | Site Map | Resourses | Forex Advertising | Forex Brokers | Forex Solo Ads | Contact Us
Any articles, systems, strategies, reviews, ratings, news, research, analyses, prices or other information contained on this website, by Aboutcurrency.com, its partners or contributors, is provided as general market commentary and does not constitute investment advice. Aboutcurrency.com will not accept liability for any loss or damage, including without limitation to, any loss of profit, which may arise directly or indirectly from use of or reliance on such information.



Copyright © 2021 Aboutcurrency.com. All rights reserved.
By using this site, you agree to the Terms of Use and Privacy Policy .
Risk Disclosure: Trading forex on margin carries a high level of risk, and may not be suitable for all investors. The high degree of leverage can work against you as well as for you. Before deciding to invest in foreign exchange you should carefully consider your investment objectives, level of experience, and risk appetite. The possibility exists that you could sustain a loss of some or all of your initial investment and therefore you should not invest money that you cannot afford to lose. You should be aware of all the risks associated with foreign exchange trading, and seek advice from an independent financial advisor if you have any doubts.