Traders consider technical analysis in forex trading very important. It gives the trader a broader view of potential market movement. It will allow them to judge the momentum and market trends better. All these are necessary to make a profitable trade. In the technical analysis of the market, traders rely on reading candlestick patterns. In the same context, this blog will talk about the outside bar pattern trading strategy. It is the advancement of reading basic candlestick patterns. It does not matter if you’re a novice or a seasoned trader redefining your trading strategies. The outside bar pattern offers valuable insight into price behavior and potential reversals.
Let me simplify it for you: It is a two-candlestick pattern where the special thing is that the second candle has to engulf the range of the first candle. This means that the high and low of the second candle surpass the high and low points of the preceding candle.
What does it mean? The formation of the pattern reflects a temporary shift in market sentiments. This can be a hint at a potential breakdown or reversal. It can hold for bullish sentiments and market sentiments, which makes it useful for many market strategies.
This guide will delve into a better understanding of outside bar patterns.
Why is it formed? What are its significance and practical applications in forex trading?
What is an Outside Bar Pattern Trading Strategy?
It is a price action technique that traders use in the forex market to predict market reversal or continuation. That too by using candlestick patterns. The technique revolves around the formation of an outside bar. It is a candlestick pattern that completely engulfs the high and low of the preceding candle.
When the pattern forms, it shows market volatility and indicates strong buying or selling.
1. Main Features of an Outside Bar
Market Sentiment: The formation of an outside bar reflects a strong tussle between buyers and sellers. It leads to a clear market direction as the bar closes.
Market Range: The outside bar has a higher high and a lower low when compared to the preceding bar.
2. How Does the Strategy Work
a. Identifying the Pattern
Step 1: Look for an outside bar in the timeframe you currently are working.
Step 2: A trader can confirm the outside bar if it has a higher high and a lower low than the preceding candle.
b. Understanding the Market Trends
Case 1 (Trend Continuation): In an uptrend, a bullish outside bar can signify that the price will keep going up.
Case 2 (Trend Reversal): In a downtrend, the bullish outside bar means there is a chance for a potential reversal of a trend. It could be vice versa for the bearish bar.
3. Entering a Trade
a. Breakout Entry
If the price moves above the outside bar’s high, consider it a buy signal. If the price moves below the low of the outside bar, consider it a sell signal.
b. Retracement Entry
To enter into the trade, wait for the price to pull back. It will give you a better risk-reward ratio.
4. Risk Management
Setting a stop-loss: For buy traders, put your stop-loss below the outside bar’s low. For sell trades, place it above the outside bar’s high.
5. Taking Profit
Risk-to-Reward: Keep a risk-to-reward ratio of 1:2 or 1:3. Avoid trading near important levels like support/resistance (price may often reverse from here).
Bullish and Bearish Outside Bar Candlestick Patterns
These are candlestick patterns that hold significant importance in technical analysis. Traders rely on the reliable bullish and bearish outside bar candlestick patterns. These patterns provide insight into continuation or potential price reversal. Here is an overview of the patterns.
1. Bullish Outside Bar Candlestick Pattern
- The pattern indicates a potential reversal from a downtrend to a strong uptrend.
- It also signifies the stronghold of buyers in the trade rather than the sellers.
How is it Formed, What is The Trading Strategy, and What is The Psychology Behind it?
The main criterion for a bullish outside bar candlestick is that the second candle should completely engulf the first one.
- Candle Colors: First Candle: Red/Black, Second Candle: Green/White.
- Formation Point: At the end of a downtrend or after a retracement in an uptrend.
- The first candle reflects bearish momentum.
- The second candle opens lower or gaps down to the first one but witnesses a strong buying force. It pushes the price above the high of the previous candle.
- This shift is an indication of the beginning of a bullish trend.
- Enter the trade and buy above the high of the second candle.
- Keep a stop-loss below the low of the second candle.
- The target should be based on key resistance levels or a risk-reward ratio of 1:2.
2. Bearish Outside Bar Candlestick Pattern
The bearish outside bar pattern may signal a downtrend from an uptrend.
How is it Formed, What is The Trading Strategy, and What is The Psychology Behind it?
- The second candle engulfs the first candle. Where the second candle’s high is higher and low is lower than the first candle.
- Candle Colors: First Candle: Green/White, Second Candle: Red/Black.
- Formation Point: After an uptrend or during a pullback in a downtrend.
- This pattern generally forms at a key resistance level.
- The first candle represents strong buying pressure, representing bullish sentiment. The second candle opens above or within the first candle’s range (gap up). It experiences strong selling pressure and closes below the first candle’s low.
- This shift is an indication of the beginning of a bearish trend.
- Enter the trade and place the sell order below the low of the second candle.
- Keep a stop-loss above the high of the second candle.
- The target should be based on key support levels or a risk-reward ratio of 1:2.
Outside Bar Pattern Trading Strategies
Both the bearish and bullish outside bar candlestick patterns are versatile tools in forex market technical analysis. Let’s examine three different trading strategies using outside bar patterns.
| Strategy | Features | Entry | Stop-Loss | Take Profit |
| Trend Reversal | Ideal for a potential reversal at key support/resistance levels. Indicators Used: MACD & RSI. | Target next resistance (bullish). Next support (bearish). | 1. Below the low (bullish) of the second candle. 2. Above the high (bearish) of the second candle. | 1. Target next resistance (bullish). 2. Next support (bearish). |
| Bullish: Buy above the high of the bullish outside bar. Bearish: Sell below the low of the bearish outside bar. | An outside bar pattern forms after a pullback or retracement. Indicator Used: EMA. | Below the low (bullish) of the second candle. Above the high (bearish) of the second candle. | 1. Below the low (bullish) of the second candle. 2. Above the high (bearish) of the second candle. | Use Fibonacci extensions or recent swing highs/lows. |
| Breakout | Suitable for breakouts after consolidation. | Below the low (bullish) of the second candle.Above the high (bearish) of the second candle. | 1. Below the low (bullish) of the second candle. 2. Above the high (bearish) of the second candle. | Traders can use the height of the consolidation range to predict the targets. |
Important: The reliability of a trade increases with high volume during the outside bar.
Benefits and Problems of Outside Bar Trading Strategy
| Aspect | Benefits | Problems |
| Clarity | It provides clear entry and exit signals. | Entry or exit signals need confirmation from other indicators. |
| Versatility | Performance may be subjected to volume, trend strength, and volatility. | Performance may be subjected to volume, trend strength and volatility. |
| Timeframes Option | Work across multiple timeframes from intraday to weekly charts. | Traders will get reliable signals in higher timeframes, but this may require larger stop-loss levels. |
| Learning Curve | It works in different market conditions like continuations, reversals, and breakouts. | Practice is required to differentiate between valid outside bars and false setups in a live market |
| Profit | Practice is required to differentiate between valid outside bars and false setups in a live market. | There is a high chance of missing the profit target if the market lacks momentum. |
Conclusion
In this blog, we have studied the outside bar pattern trading strategy. It is a very effective technical strategy. It gives us full insight into market sentiment and potential reversals. Combining it with other technical indicators will enhance its reliability. Traders can use indicators like Fibonacci retracements, moving averages, and support/resistance levels.