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Not all pin bars are created equal. One of the most challenging aspects of learning to trade price action is developing a set of criteria by which pin bar setups can be evaluated.
We all know pin bars aren’t hard to come by. In fact, I can pretty much guarantee that I can spot at least two pin bars at any given time on any currency pair. What isn’t so common is a quality pin bar setup that’s worth the risk.
So how do we determine the quality of a pin bar?
I’ve previously written about the pin bar trading strategy as well as price action confluence. So for this lesson we’re going to focus solely on where and how the pin bar forms in relation to a key level.
In order to focus solely on the pin bar formation, we’re going to assume a few things are always true for this lesson.
Now that that’s covered, let’s dig in!
Before we get into the ideal placement of a pin bar, we first need to understand what makes a pin bar so effective in the first place. To accomplish this, we need to go back to the basics and talk about supply and demand and how it relates to the Forex market.
Supply is simply the amount available at a certain price, whereas demand is the amount wanted at a certain price. As price increases so too does the supply as traders are more willing to sell their positions. On the flip side, as price decreases demand increases as traders are willing to buy more at lower prices.
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I’ve included the well-known supply and demand curves below to illustrate this relationship.
Notice how in the supply curve below, the number of units for sale increases as price increases. To put this in trading terms – the higher the price, the more willing traders are to sell their positions.
The demand curve, on the other hand, is the exact opposite. As price increases the number of units desired decreases. This is because traders are less willing to buy in a more expensive market.
So why is this important when it comes to the quality of a pin bar? To fully appreciate the importance we need to realize that a pin bar is only as good as the level at which it forms.
Supply and demand are important concepts because they essentially define the support and resistance levels we see on our charts. It’s literally the lifeblood of Forex price action trading. And without these key levels, pin bars wouldn’t be the effective price action trading strategy that they are.
Let’s look at a recent NZDUSD weekly chart as an example.
Notice how the market stays within this channel (for the most part). As price approaches the lower level, traders step in and begin demanding more which pushes the market higher. Conversely, as price approaches the upper level, traders begin to sell off their position, increasing the market supply which pushes the market lower.
We can use these levels to form ideas of where the market might turn. It’s then up to a price action pin bar to confirm the validity of the level. In fact, I see a few pin bars on the weekly chart above which confirmed that the supply:demand curve was likely to shift.
Now that we’ve combined the concepts of supply and demand and also touched on the subject of using the pin bar as confirmation, let’s discuss the importance of a pin bar’s proximity to a level.
Just as a Structural Engineer uses stress testing equipment to determine the strength of a bridge, we use pin bars to test the strength of a key level. This is when the placement of a pin bar relative to a key level is important.
There are two main types of pin bars when it comes to testing a key level.
I find that a lot of traders believe an immediate bounce from a level to be ideal. However, in my experience, the best pin bars to trade are the ones where the tail of the pin bar protrudes through a key level. This isn’t to say an immediate bounce is bad, but it does create a few challenges that I’ll elaborate on in a moment.
Before we go too far, let’s take a look at both examples. The first example shows a pin bar that bounced immediately from a key level. The other shows a pin bar where the tail is protruding through the level.
The bullish pin bar to the right is well-formed and occurred at a key level. However, the market hasn’t tested the entire area. The fact that the market has reacted sharply to this level shows that demand is strong above the level, but what about below it?
This is important because remember that even though we often call these levels, they are in fact areas or zones. What if in this example the real support level was 20 pips lower? Now we have a bullish pin bar that looks great, but it isn’t actually testing a key level.
Similar to the example above, the bullish pin bar to the right is well-formed only, this time, it has fully tested the entire support area. With the tail of the pin bar protruding through the level, we can easily see that demand is strong throughout this area.
This type of pin bar tells us that there’s significant demand above and below the level. Traders are showing their approval of current prices by keeping the market above the key support level.
One reason why these levels need to be thought of as areas rather than an exact price is that they won’t always be the same for every trader. One trader may draw a level at the daily close while another may draw the level at the wick of the daily candle.
There is actually a proper way to draw the level, which I’ll get to in a later lesson. For now just recognize that the placement of the two levels in the illustrations above won’t look the same for everyone, even if you’re looking at the same setup. This is because you may draw a level at 85.45 while the next trader has the same level drawn at 85.55. It’s simply a different way of viewing the same area on a chart.
That said, the extent to which a pin bar tests a level is extremely important. It isn’t to say that the first example above isn’t a valid setup, because it is. But in my experience the more the tail of a pin bar protrudes through a level the better. It tells me that the level has been thoroughly tested and is worth further consideration.
The protruding pin bar also has the upper hand when it comes to stop loss placement. This is because when the tail of the pin bar protrudes through a level, it becomes much easier to “hide” our stop loss beyond the level. This way the market has to work harder to invalidate the setup, thus giving us a better chance of making a profit.
Here are two examples:
In this example, we have a pin bar which bounced immediately from a key level. The pin bar strategy says that we place our stop loss behind the tail of the pin bar, as you can see in the image to the right.
The challenge we face with this particular pin bar setup is that by placing our stop loss here we are just a few pips away from the key level. Our stop loss is left vulnerable should the market retest the level, which happens often.
Here we have a pin bar where the tail has protruded through the level. Following the same stop loss placement, we now have a much greater distance between the key level and our stop loss.
With this setup there’s a lesser chance of our stop loss being hit should the market retest the key level. This gives the market more room to breathe and allows us to stay in the trade longer.
The Forex market is all about price and time. Every chart has a Y axis and an X axis. The Y axis is represented by price while the X axis is represented by time. The combination of the two is what gives us the ability to trade price action.
Why is this important with respect to determining the quality of a pin bar?
Because if the market hasn’t put in enough price or time (possibly both) between a reversal pin bar and the last swing high or low, the quality of the pin bar is questionable.
Below is an example of a failed bearish pin bar. Continue reading to find out why this happened.
Notice how in this example, once the market broke the key level it spent five days traveling lower. This gave us the swing low as illustrated above. From here it’s perfectly logical to look for a pin bar reversal from the level, which is the red line in the chart above.
However, instead of taking another five days or more to get back to this level, the market retested it in less than 48 hours. The price action was telling us that there was significant demand below this key level. So when the bearish pin bar formed as noted above, the quality of the pin bar was put into question.
As we can see from the example, the pin bar setup failed. The bullish momentum from the prior day was too much for the bears to handle. In essence, there wasn’t enough time between the swing low and the retest of the level.
A more favorable retest for a short entry would have looked like this:
Notice how much more space and time we have to work with in this example. If NZDUSD had formed this price action instead of the former, it would have made the bearish pin bar setup much more favorable.
This type of formation shows us that while there is demand below this level, it isn’t likely to outweigh supply given the bearish pin bar that formed.
Becoming a profitable Forex trader is all about learning to read supply and demand. In other words following the natural flow of the market. In the first example the market was still flowing upstream, so by going short we were fighting the market flow.
The second example shows that demand below this level is stable at best. The bearish pin bar then becomes our signal to rejoin the bear trend as supply starts to outweigh demand once again.
Although there are many other factors that go into determining the quality of a pin bar, I’m hopeful that this lesson has shed some light on two factors I’ve found to be important. Just remember that there’s no “one size fits all” when it comes to trading Forex. This is true for everything from finding the trading strategy that works best for you to the topics discussed in this lesson.
There will always need to be some discretion applied which means treating each pin bar setup separate from the last. Therefore it’s best to analyze each setup based on its own merits rather than assume one golden rule for all setups. In other words, these are things I look for in a pin bar setup, but it doesn’t mean I won’t trade a really great setup if it goes against one of the factors I’ve outlined here.
As always, trade safe!