Among all of the prediction tools available to forex traders, perhaps none are as reliable as candlestick patterns. Traders who devote the time necessary to understand and recognize patterns as they emerge, find this method of technical analysis to be invaluable when trying to read the market, and predict where prices will go.
A big draw of candlestick patterns as a means of technical analysis is the simplicity. Patterns emerge when they display the open, high, low, and close of a given trading period. The opening to the high is represented by a line, the high to low is represented by a bar, and the low to the close is represented by another line. When these figures are looked at all together, the resulting shape resembles a candlestick.
Like all other types of candlestick patterns, an outside bar candlestick pattern is a price action indicator (Pattern) used to predict price movement in the forex market. Outside bar candlesticks are recognized when the outside bar overshadows or engulfs the inside bar.
As we just mentioned, outside bar candlesticks form when the outside bar overshadows or engulfs the inside bar. In a trending market, the patterns signify a major reversal.
The conditions that enable the onset of outside bar candlestick patterns are when the market has engaged with a trend yet most recently, a small price range has indicated indecision. After that, a price gap moves away from the most recent close price, giving investors the appearance the previously recognized trend is still together. Despite this appearance, the gap in price is quickly filled and when it comes time for closing, the price has finished outside the previous day’s open.
Such a price move can leave investors feeling tricked and trapped because a price believed to have been an existing trend proves to not be by day’s end. When the outside bar candlestick forms, it indicates that the prevailing mindset and beliefs of investors have changed over the course of the day.
Bullish patterns abide by two main principles. First, these patterns need to form within a downturn (if they don’t, they’re merely a continuation pattern). Second, the majority of bullish reversal patterns need bullish confirmation in order to be revealed as such.
Moving in the other direction, just like bullish patterns needing bullish confirmation, bearish patterns require bearish confirmation. Bearish reversal patterns can also form with one or more candlesticks. This reversal points to the fact that selling pressure exceeded buying pressure for a few days.
We will cover the confirmation needed later on under the reversal and Trend Continuation strategies.
Bearish Outside Bar Candlestick
Bullish Outside Bar Candlestick
As we’ve exhaustively written about in other articles, when it comes to being a successful trader, one of the most, if not the important things required, is to strictly follow a well-crafted risk management strategy. Of course, depending on your situation, there are slight tweaks that can be made but when considering entry and exit for trading with an outside bar candlestick pattern.
Here are some rules you should abide by in chronological order:
Here are two strategies to trade the outside bar candlestick:
The first strategy we’ll look at when discussing trading outside bar patterns is the reversal. This happens after a long momentum candlestick has suddenly lost its momentum. In this scenario, the downturn hits a sudden end when multiple inside bar candles appear following the momentum candle. The emergence of this pattern is one of the most recognizable and well-known reversal patterns and it clearly shows a change in momentum.
The first confirmation of a trend reversal is the break of the low/high of the outside bar, which would trigger your trade against the previous trend. The second confirmation of a trend reversal presents a little after, only when a new pivot forms in the direction of the new trend.
The second strategy is looking at trend continuation signals. These signals occur when outside bars are present during pullback phases.
The confirmation of a trend continuation outside candle is the break of the low/high of the bar in the direction of the previous trend, that would also be the entry point of your trade.
Like any strategy or indicator, there are times when certain deficiencies make it less desirable to trade with. In the case of the outside bar candlesticks, the first issue is that stop-loss distances can be very big.
The next disadvantage of using these candlesticks as part of any strategy is that it often takes a long time before profits are realized. This is due to the fact that an outside bar may have already moved and the next few bars are merely processing the previous outside bars move.
The last problematic aspect of this strategy is that it’s very tempting to trade them whenever they appear. As always, you should only trade them when the rest of your information aligns with the proposed trade.
On the flip side of the several disadvantages to candlestick patterns, there are, of course, advantages.
The first one, for anyone who takes some time to learn about candlestick patterns, is that they’re very easy to locate. The rules for their formation are simple and they’re easy to understand.
The next benefit of outside bar patterns is that the market can move very far upon the appearance of these patterns and can result in a windfall of profits.
Finally, if you happen to spot these patterns on your daily charts, it’s possible you’ve caught a full trend reversal which could prove very lucrative.
The ability to spot and take advantage of outside candlestick patterns as they emerge in the forex market is an incredibly valuable tool for traders who know how to trade with them. As long as you’re able to trade within the confines of the risk management setup you’ve created, candlestick patterns can vastly improve already strong technical analysis arsenals.
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