Developing & Refining Your Edge With Chart Patterns

Developing & Refining Your Edge With Chart Patterns

An edge is essential to trading financial markets. Statistically, an edge is defined as a strategy’s ability to yield positive expectancy over time. If a strategy does not yield positive expectancy over time, then it has no edge. Trading is basically the repetitive act of a trader exercises his edge in the market. Every serious trader is essentially doing one of two things: he is either trying to find an edge or he is seeking to refine his edge.

One way that traders often seek to find or refine their trading edge is by employing the use of price patters. There are numerous types of price patterns, but some of the simplest and most powerful are single and two-bar Japanese Candlestick formations. In this article we are going to break down three of the most common types: the Double Bar Low Higher Close/Double Bar High Lower Close, the Outside Bar, and the Pin Bar.

DBLHC/DBHLC

This pattern is a very strong reversal or trend continuation pattern, and they can be identified when engaging in forex trading or other less risky markets like buying stocks online.

A very nice Double Bar High Lower Close (DBHLC) can be found on many charts. Basically, it is a two-bar candlestick formation where the two bars share a HI, and then the second one closes lower than the low of the previous bar. A DBLHC would be the exact opposite. The two bars would share a LO, and then the second bar would close higher than the HI of the previous bar.

Trend Reversal
DBLHC forms at the bottom of an extended bearish run
DBHLC forms at the top of an extended bullish run

Trend Continuation
DBHLC forms in a bearish trend
DBLHC forms in a bullish trend

A forex trading demo is a great way to see these price patterns form in real time.

Outside Bar

The Outside Bar is defined as a candlestick that completely engulfs the previous candlestick, meaning the HI and LO of the previous candlestick is completely within the HI and LO of the current candlestick.

This candlestick formation is traded by entering the market in the direction of the Outside Bar when the 3rd candlestick opens and breaks above the HI or below the LO. You would be looking for a long entry if the Outside Bar is a green candle. Therefore, when the next candle opens and breaks, an entry signal has been triggered. Stop loss is always underneath the Outside Bar.

Psychology Behind Outside Bar

The OB pattern denotes a period of consolidation and price contraction. As price contracts and consolidates, a breakout is soon to occur. Therefore, this pattern is seen as a breakout pattern, with the Outside Bar showing the first sign of a possible breakout.

Location is Very Important

The exact location where these candlestick patterns form on a chart is very important. For example, candlestick patterns that form in the middle of congestion or a sideways market are not reliable. In fact, the best setups will always be in the direction of the overall trend.

Timeframes Also Very Important!

Classical technical analysis tells us that price patterns which form on higher timeframes are much more reliable than patterns that form on lower timeframes due to the simple fact that patterns on higher timeframes encompass a wider set of data. Therefore, these candlestick formations will not be as reliable in an fx scalping strategy as they will be on the 1 Hour, 4 Hour and Daily Charts.

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