Candlestick patterns are quite popular chart patterns. Traders recognize a variety of candlestick patterns in trading charts to forecast stock price movement. Some of these are considered strong trend reversal indications and so, when traders identify them in trading charts, they form trading strategies around those. We have discussed some of the candlestick trading strategies in earlier blogs. So, in this blog, we are going to elaborate on the master candle strategy, a popular trading strategy used in the FOREX market.
Among candlestick formations, the engulfing patterns are quite famous and considered one of the strong trend reversal signals. Master candles (MC) is also a form of engulfing candles. Those who are unfamiliar with the term a master candle is a prominent long body candle that forms at a breakout.
A textbook master candle forms when an asset price is moving within a range, followed by four candles, all opening and closing within the body of the first (or the MC, engulfs the opening and closing of the four following candles). The appearance of a master candle gives a clear indication to a breakout point, and a master candle trading strategy involves planning a trade in the break.
In a Forex market, a breakout is a point in the current trend that denotes early signs of a potential trend change, allowing traders to take a position. It happens when an asset price moves above the resistance line or below the support line with increased volume. A breakout trader will assume a long position when the price moves above the resistance level and conversely, enters a short, when the support line is violated.
A master candle is a significant breakout pattern, and the primary advantage is, it is bias-free. It indicates breakout irrespective of the ongoing market trend.
Developing A Trading Strategy With A Master Candle
Master candle trading strategy is a breakout trading strategy. It allows you to determine a new range of price between the maximum and minimum of the candle. When the breakout happens, we can expect the price to move significantly towards the direction in which the breakout occurred. It is, therefore, essential to incorporate a master candle trading strategy in your FOREX trading.
A master candle is direction neutral. So, when a master candle forms in the trading chart, the trader waits for the confirmation candles to appear in one direct or the other. The trader opens a position only after confirming it isn’t a fake breakout.
Rules to follow around master candle trading strategy
- One primary rule that applies to the master candle is not to trade near the support/resistance
- If the support or resistance is closer than the size of the master candle, then refrain from trading
- Place a stop loss in the opposite direction of the trend at the other end of the master candle. For example, while entering a long position, the stop loss is placed at the low of the master candle
- An ideal master candle size is usually of 30-150 pips (percentage in points) depending on the traded pair
- If traders find a candle that is too wide to maintain all the risk parameters, they usually place the stop at the middle of the master candle
- Avoid trading when the master candle falls outside the pips range mentioned above
- Traders usually place a limit order with 5-10 pips buffer
- Take a position when a candle breaks the high or low of the master candle
The thumb rules of entering long or short using a master candle suggest the following.
When you are entering a long position, place buy stop pending at five pips above the high of the MC, plus the cost of the spread. However, when entering a short, the positions of the stop buy limit switches, and a stop sell pending order is placed five pips below the lower point of the master candle.
A master candle can be used for any asset type, but it works better for assets with higher volatility with strong movements, like the FOREX market.
Trading with the indication of a master candle is one of the most straightforward trading strategies, but it isn’t without downsides. You need to watch out for false breakouts, which will result in losing trades. It is why most experienced traders avoid entering the market at the first entry after the formation of the master candle. They wait for the scouting party to appear, which are candle chart patterns that form a beachhead, to confirm the sustainability of the price change.