To a beginning trader, making sense of the price fluctuations throughout the day can be a strenuous mental exercise. By identifying specific price patterns that have a better than average chance of success, we can increase our profitability.
One of they ways that we can do this is by using Japanese Candlesticks. They were popularized by the Japanese during the 1700's to summarize the trading activity and price fluctuations of rice.
It offers price action traders a highly efficient and informative summary of a given day's trading. A candlestick pattern summarizes the day's price activity by providing the opening price, the closing price, the day's high and low and whether the currency pair closed higher or lower than it opened.
The end result of these price points are rectangles of various heights, with vertical line protrusions on the top and or bottom, to indicate a high and/or low that is different than the open and close trading prices.
Color summarizes whether the pair closed higher or lower on that day.
When the candlesticks of several days are compared, predictive indicators, in the forms of well known patterns, to which traders should take note, emerge.
In this article, we discuss the use of candlestick outside bars in Forex trading and its use as a powerful price predictive indicator.
An outside bar candlestick pattern occurs when the candlestick of a given trading session is larger than the prior trading session's, creating an engulfing candle pattern. The reason the candlestick is larger is because the price activity range was greater than that of the session(s) to which it is being compared, increasing the height dimension of the candlestick rectangle.
How Traders Use Outside Bars
The specific relationship of the outside bar to the prior trading session(s) determines how the pattern should be interpreted by an trader looking to make a trading decision.
A bar that is close to the center indicates that of the bullish and bearish traders throughout the day, neither was able to dominate the session. These are ignored by traders and are seen as signs of indecision.
A candlestick bar which occurs on the outside of the prior day's bar, however, shows that there was a market attempt to restart a prior price trend, which failed, and as a technical trading indicator, predicts a considerable market retrace of the current price.
Outside bars, which appear in retracing patterns against trends which were already strong, point to a continuation in the trending direction.
For example, a bullish outside bar, as indicated by a candle which has a higher closing than opening price, that retraces a bearish trend is a strong indicator that there will be a further price retrace. Briefly explained, the day's activity began as bearish, extending below the previous bar, which would encourage bearish traders to increase short positions to further benefit from the prior bearish trend.
The market reversal, however, that caused the bearish momentum disappeared, leaving bearish traders stuck with covering their open short positions.
This is a buying opportunity for bullish traders to increase their investment, buying into the trend. The bears will be looking to cover their position(s) to mitigate the large losses sure to follow in such a bullish trend.
The same concept applies relatively, though in inverse relationship to bullish traders looking at a bearish outside bar candlestick. Therefore, a bearish outside bar that retraces a bullish trend indicates a reversal of the the bullish trend as bullish traders are stuck in unfavorable long positions which they will attempt to mitigate their losses from.
How to Find this Price Action Pattern
At this point, you are probably interested in how to make strategic use of outside bars.
Intra-day candlestick patterns can be checked every few hours for the day's price movement and for an overview of the day's type of candlestick patterns at that given point in time.
An easy to use alert indicator with customizable parameters can be configured to send notifications alerting to the occurrence of the outside bar.
Additionally, many trading platforms that have tools which let traders create candlestick charts, providing drop down list boxes to select currency and granularity parameters. As you probably know, I use Oanda as my broker and Metatrader 4 for charting.
The outside bar is one of the patterns that you should keep an eye on and learn how to trade. It provides important buy and sell clues and is therefore a useful technical setup.
Staying on top of the signals using an alert indicator, checking the candlestick(s) throughout the day and using website candlestick tracker tools are critical means by which you can stay on top of price action and the outside bar engulfing candle patterns.