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We have looked at some of the more well-respected chart patterns that can form as trend reversal take place. However, these can often take some time to form and are almost inevitably never the exact same shape twice. Quicker to appear and perhaps easier to form a trading decision from, are two bar patterns. Consider the simple inside day/outside day scenario, which equates to the bullish or bearish engulfing pattern. An inside day is one where the high to low range falls within the previous bar’s high to low range, ie neither a new high or low was made. Conversely for an outside day both the bar’s high and low respectively exceeded the high and low of the preceding bar.

Why should such bars be of any interest? You need to think through the psychology of the influential ‘trading herd’ when considering the scenario under which such bars form. The inside bar denotes a market state where there is likely to be lack of interest and lack of hard opinion as to the future direction of a market and this can be the prelude to a change in sentiment. It might be considered analogous to high or low water ‘slack’ from a tidal perspective. The most important thing to observe is the ‘breakout’ direction on subsequent bars following an inside bar, as this will indicate the direction the new ‘tide’ is running in.

Conversely the outside bar shows great divergence of opinion as to market direction during its formation. The relationship of the close to the bar range on an outside bar will sometimes give some help in reading it, however, witnessing the direction that price moves on subsequent bars will be the best gauge. The outside bar has been a good warning of a possible sea change in trend. Generally if such a bar appears after a significant uptrend and especially if the close on the bar is near to the low then expect a possible top has formed and vice versa for an outside bar following a downtrend that has a close near to its bar range high. The opposite bar extreme can be used as a level from which to set a protective stop on any trade initiated off such a bar. So just above the high of an outside bar that occurs after an uptrend would be a good stop level for example.

This technique can be applied to bars of virtually any time scale from intra-day bars to daily or longer time periods. In particular, some research in America has shown that applying it to two week bars has produced significant outperformance over the longer term. However, as with all technical methods it is best to seek confirmation of any signal by applying an unrelated technique such as a trend line break or momentum divergence to give added reassurance that the signal can be trusted.