Inside and outside bars hold significant appeal among price action traders and for valid reasons. While relying solely on individual candlestick patterns may not typically yield reliable trading outcomes, incorporating these patterns within the appropriate chart context can enhance the robustness of trading signals.
The outside bar pattern is characterised by two candlesticks: the first is generally smaller, while the second engulfs the entire body of the first, giving rise to the term “outside bar.”
The implications of an outside bar can vary greatly depending on the context of the surrounding chart. This article will explore three distinct trading strategies and examine how the outside bar can serve as a pivotal trigger in each scenario.
What is an Outside Bar Trading Strategy?
Among the various prediction tools available to forex traders, candlestick patterns are often considered one of the most reliable. Traders who invest the time to understand and identify these patterns as they form find this method of technical analysis invaluable for reading the market and forecasting price movements.
One of the key attractions of using candlestick patterns in technical analysis is their simplicity. These patterns display the open, high, low, and close of a specific trading period. A line represents the opening to the high, a bar depicts the high to low, and another line shows the low to the close. When viewed together, these figures form a shape that resembles a candlestick.
Like other candlestick patterns, the outside bar candlestick pattern serves as a price action indicator used to predict market movements in forex trading. An outside bar candlestick pattern is identified when the outside bar overshadows or engulfs the preceding inside bar.
The Mindset that Enables Outside Bar Candlesticks
Outside bar candlestick patterns typically form under specific market conditions. Initially, the market engages with an ongoing trend, but a small price range signals indecision. Following this, a price gap appears, deviating from the most recent close, suggesting to investors that the established trend continues. However, this gap is rapidly filled, and by the time the market closes, the price ends up outside the previous day’s open.
This price movement can mislead and trap investors, as what appeared to be a continuation of the trend turns out to be a false signal by day’s end. The formation of an outside bar candlestick indicates a shift in investor sentiment and beliefs throughout the trading day.
Bullish and Bearish Outside Bar Candlestick Patterns
Bullish patterns adhere to two fundamental principles. First, they must form within a downtrend; otherwise, they are merely continuation patterns. Second, most bullish reversal patterns require bullish confirmation to validate the reversal.
Similarly, bearish patterns need bearish confirmation. Bearish reversal patterns can form with one or more candlesticks, indicating that selling pressure has surpassed buying pressure over a few days.
We’ll discuss the necessary confirmation later under reversal and trend continuation strategies.
Entry and Exit Rules for Outside Bar Candlestick Patterns
As we’ve discussed extensively in other articles, one of the most critical aspects of successful trading is strictly following a well-crafted risk management strategy. While slight adjustments can be made based on individual circumstances, the following guidelines should be followed when trading with an outside bar candlestick pattern:
- Never risk more than 1% of your account.
- Buy at one cent above the bullish pattern.
- Limit the initial stop loss to 2x the ATR indicator value from the entry.
- Set the first profit target at 2x the ATR indicator value from the entry.
- Close half the position when the initial profit target is hit.
- Move the stop loss to break even.
- For the remaining half position, use a trailing stop loss set at 2x the ATR indicator value after each new high.
- Move your stop loss to break even if the price reaches 80% of the first target.
- Manually close the trade if the price reaches 7x the original risk before being stopped out.
By following these rules, traders can better manage risk and increase the likelihood of successful trades using outside bar candlestick patterns.
How to Trade Outside Bar?
1. Reversal Strategy
The first strategy focuses on trading outside bar patterns as a signal for a reversal. This occurs when a strong momentum candlestick suddenly loses steam. In this scenario, a downtrend comes to an abrupt halt when multiple inside bar candles appear following the momentum candle. This pattern is one of the most recognizable and well-known reversal indicators, clearly demonstrating a shift in momentum.
- First Confirmation: A trend reversal is first confirmed by a break of the low/high of the outside bar, triggering a trade against the prior trend.
- Second Confirmation: The second confirmation occurs when a new pivot forms in the direction of the new trend, providing further validation of the reversal.
2. Trend Continuation Strategy
The second strategy involves identifying trend continuation signals. These signals appear when outside bars are present during pullback phases within an ongoing trend.
– Confirmation: A trend continuation outside the candle is confirmed by a break of the low/high of the bar in the direction of the existing trend, which also serves as the entry point for the trade.
Problems with Outside Bar Forex Candlestick Strategies
Like any strategy or indicator, the outside bar candlestick pattern has its limitations, making it less desirable to trade with at times.
The first issue is that stop-loss distances can be quite large, potentially exposing traders to significant risk.
Another disadvantage is that it often takes a considerable amount of time before profits are realized. This is because an outside bar might have already moved significantly, and the subsequent bars are often just processing the previous movement of the outside bar.
Lastly, it can be very tempting to trade every time an outside bar appears. However, it’s crucial to only trade these patterns when all other information aligns with the proposed trade, ensuring a more reliable and informed decision-making process.
Benefits of outside bar strategy
Despite the several disadvantages of candlestick patterns, they also offer notable advantages.
First, candlestick patterns are very easy to identify for anyone who invests the time to learn about them. The rules for their formation are straightforward to understand.
Another benefit of outside bar patterns is their potential to drive significant market movements. When these patterns appear, they can lead to substantial profits.
Lastly, spotting these patterns on daily charts can sometimes indicate a full trend reversal, which can be highly lucrative if traded correctly.
Summary
The skill to identify and capitalize on emerging outside candlestick patterns in the forex market is an immensely valuable asset for traders proficient in utilizing them. When adhering to a well-structured risk management strategy, incorporating candlestick patterns can significantly enhance the effectiveness of an already robust technical analysis toolkit. You need to learn different forex trading strategies and choose the one which fits your needs.