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Last Updated November 11, 2016
There is a special section in every good price action trader’s toolbox reserved for Forex candlestick patterns, and for good reason.
Aside from technical chart patterns such as the head and shoulders or bull and bear flags, these candlesticks can offer you a chance to understand the sentiment that’s driving a particular market.
In this lesson, we’re going to cover three of my favorite Forex candlestick patterns. I’m going to assume that you’re familiar with Japanese candlesticks. If not, you may want to visit this post and then come right back.
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By the time you finish this lesson, you’ll know how to identify these formations, what makes them so lucrative as well as the price structures to stay away from.
I’ll be using the terms “candlestick” and “bar” interchangeably throughout this lesson. A pin bar or an inside bar can technically be called a pin candlestick and inside candlestick, but these aren’t nearly as common.
Let’s dig in!
Let’s begin with my favorite candlestick called a pin bar. Like most formations, these can form as either a bullish or bearish signal.
So what exactly qualifies as a pin bar?
Let’s take a look…
I hope the video above cleared up any questions you may have had about the pin bar.
Here’s an illustration of the characteristics we just discussed.
Before we get into why these are so powerful, let’s first break down the components of the structure.
The tail of a pin bar is also called a “wick” or “shadow” and represents the most critical element of the pattern. As a general rule, the tail should make up at least two-thirds of the entire pin bar. Notice how the tail on the two pin bars in the illustration above are much more pronounced than the rest of the structure.
Next is the body. The body represents the open and close of a pin bar and can vary in size. However, there shouldn’t be much space between the open and close.
The first rule about the tail should help keep you in line. After all, if the tail is at least two-thirds of the candlestick, then the body should be relatively small.
The nose of the pin bar, which is sometimes nonexistent, is important only as it relates to the tail and body. If the tail follows our rule of being at least 2/3 of the entire pin bar, and the open and close are close together, then the nose shouldn’t be a make-or-break characteristic.
Just know that the nose should be as small as possible, much like the image above.
When it comes to Forex candlestick patterns, the pin bar is by far my favorite.
Now that you have a firm grasp on the characteristics to look for let’s get into a couple of examples.
The first is a bullish pin bar that occurred on the NZDJPY daily chart.
Notice how after an extended move lower, the NZDJPY found support and subsequently formed a bullish pin bar.
This pattern triggered a sharp move higher back to previous swing lows, which acted as resistance.
Next up is a bearish pin bar that occurred on the EURUSD daily time frame.
In this case, the EURUSD had carved out an ascending channel. On the second retest of resistance, sellers came out in force and eventually formed a bearish pin bar.
This particular candlestick formation triggered a 400 pip drop over the next eighteen sessions.
I wrote a more detailed lesson on the pin bar where I get into what makes a tradable setup as well as where to place your stop loss and target.
The inside bar is one of the more misinterpreted Forex candlestick patterns simply because they aren’t hard to find. This observation is especially true for those trading anything less than the daily charts.
Take a peek at the video below where I explain the characteristics of the inside bar and an easy way to determine if one is bullish or bearish.
To recap, here’s an illustration showing the attributes of an inside bar:
The inside bar’s range (high to low) should be engulfed entirely by the previous bar’s range, also called the “mother bar.”
Another way of saying it is that the mother bar should completely engulf the range of the inside bar.
When it comes to Forex candlestick patterns, the inside bar is my second favorite pattern to trade.
Here is an excellent example of the inside bar in action:
Notice how the inside bar in the chart above formed during a strong uptrend. An established trend is a requirement for trading this particular candlestick pattern.
The reason for this is that the inside bar is nothing more than consolidation. So we have a strong trend followed by consolidation which leads to a breakout in the prevailing direction.
Pretty simple stuff, right?
The next chart shows two bearish inside bars that formed on the EURUSD daily chart. Note that the pair had been in a downtrend for several months, therefore these are bearish continuation patterns.
You could make the case that the first signal in the chart above was also a pin bar, and I would agree. The combined rejection of former support and consolidation made for an incredibly profitable trade setup.
To learn more about inside bars, including which ones to trade and which ones to avoid, check out my detailed lesson on trading the inside bar pattern.
Last but not least is the engulfing candlestick. Unlike the inside bar that we just studied, this formation most often signals a reversal in the market.
Why do I call it a misunderstood pattern?
Because it takes more than an engulfing candle to warrant a position. To be considered tradable, an engulfing candle must develop at a key support or resistance level and after an extended move up or down.
Here’s a brief video that explains what I look for…
While the video above only addresses the bearish engulfing candle, the same rules apply for its inverse, the bullish engulfing.
For it to be profitable, an engulfing pattern must form at a swing high or low. Only then can it be used to formulate a trade idea.
Notice how the range of the engulfing bar completely engulfs the previous bar’s range. Hence the name, this is the most prominent and significant feature of this pattern. It’s also what makes it such a lucrative signal.
While the engulfing bar pattern is my third favorite in this lineup, it can be extremely telling if properly utilized.
Here are a few things to keep in mind when trading them…
The bearish engulfing pattern below occurred on the AUDUSD daily chart.
In fact, there were two back-to-back formations at key resistance.
As you can see, the pair had carved out a wedge pattern. The two bearish signals formed at resistance, creating two profitable opportunities.
Know that the first candlestick in the chart above is also a bearish pin bar or at the very least a bearish rejection. It’s rare, but these two patterns can sometimes overlap.
Always remember that a bullish engulfing pattern at a swing low is a sign of potential strength. It signals that the current downward momentum is likely coming to an end.
Alternatively, a bearish engulfing pattern at a swing high is a sign of potential weakness. If you see one form in this manner, the chances are good that an increase in selling pressure is on its way.
Last but certainly not least, both candlestick patterns must form at a key level to be tradable. Otherwise, you may find yourself trading a lot of false positives.
Whether you trade using raw price action or some other means of identifying favorable setups, the three candlestick patterns above will surely improve your trading.
As lucrative as these formations can be, always remember that there are never any guarantees. Just like any other Forex trading strategy, the three above can and do fail, so always protect yourself.
Last but not least, the pin bar, inside bar and engulfing pattern are most useful when combined with other confluence factors. By doing this, you greatly increase the odds of a successful trade.
Are you ready to begin using these patterns in your trading?
Then you definitely want to download the free Forex candlestick patterns PDF that I just put together.
It contains all three formations above and shows you the exact characteristics I look for when developing a trade idea.
Click the link below and enter your email to download the cheat sheet.
Justin Bennett is an internationally recognized Forex trader with 10+ years of experience. He's been interviewed by Stocks & Commodities Magazine as a featured trader for the month and is mentioned weekly by Forex Factory next to publications from CNN and Bloomberg. Justin created Daily Price Action in 2014 and has since grown the monthly readership to over 100,000 Forex traders and has personally mentored more than 3,000 students.Read more...
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