01 Feb 2010
Bar patterns: Simple, profitable but ignored

Hello and welcome to Cantos Charts Masterclass. I'm Sandy Jadeja, Chief Market Strategist at CMS FX.

As always, everything we teach you here is simply for educational purposes only and today we're going to continue our series of applying simple chart patterns.

What I want to do is take a look at a very simple technique and a very simple chart pattern. Most traders either miss or ignore the opportunity. It is by far the most simple one-day pattern that exists and it occurs on average of three to four times per month. It is also the most reliable pattern in both bull and bear markets and has a high percentage of profitability - around 73 to 76 per,cent. If you had traded just the S&P 500, this would have racked up $300,000 gain in 14 years on a single contract basis.

Now, this chart here shows you a period of a year. The red lines show you the number of occurrences that have actually happened with this particular chart pattern.

What is it? It's an inside bar and as I said, most people tend to ignore this because it is just far too simple and yet it's highly effective, so why not have this as part of your toolbox.

The inside bar pattern is when the high and the low of the current bar are within the parameters of the previous bar. So essentially, what we're saying is that the high must be lower than the previous bar's high and the low must be higher than the previous bar's low. In this chart here, this shows you a snapshot of a number of occurrences where we have seen the inside bar.

So how do we trade this? Well essentially, we want to look at the current trend. Now if the trend is down and we get an inside bar, as we have over here as indicated by the red arrow, what we're looking for is a break below the low of that bar on the very next bar.

In this instance, that has actually not taken place. In this situation here, again, we have an inside bar and once again the market hasn't broken above the high or the low of the inside bar. So again, in both these examples you would have negated the trade.

However, in this example here, the third example, we have an inside bar and the following day it breaks above the high of the inside bar and that would have triggered an order to be long.

In this situation here we had a break of the inside bar to the upside and the market closed positive and the same situation over here.

So how useful is this? Well we can see that it actually occurs quite a few times. The way to trade it, however, is the break on either the upside or the downside. If the trend is up, probability suggests that you want to be looking for a break of the high and if the trend is down, you're really looking for a market to trade lower and so you're looking for short positions.

So how do you close the position? Two ways. Either you have a set profit target which is based on volatility which is something we will discuss in upcoming lessons, or you can wait for the close of the day.

Now, as you can see, here certain cases we actually took one or two losses, but in the majority of the cases the market had netted a profitable result.

So the inside bar tends to occur more frequently within shorter-term timeframes. When longer-term timeframes are used, results tend to be better.

So basically what we're saying here is a very, very short-term pattern. You can use this on an intraday or an end of day or even on a monthly basis. The idea is though you're looking for a breakout above the high or a breakout below the low. So in other words, we're looking for a very short-term sharp move.

Now a lot of traders have been saying, well actually it occurs quite frequently on the intraday bar charts, but I tend to lose money on this. As I said, if you use a set profit target, if it breaks above the high and you have a set profit target of three to 10 points, depending on volatility and the average true range, you can capture some significant profits on this.

Now much research has been done on this particular pattern, especially by a man called Larry Williams. So you can do some research on this and find out more ways of trading this particular technique.

In this example here I've used a weekly timeframe, so it's a longer term timeframe and as you can see here, we had an inside bar and the following week the market did indeed break lower. Here, again, we had an inside bar. The market the following week broke above the high. In this situation here, we have an inside bar, but the following week the market doesn't generate either a buy or a sell signal. This one here we have an inside bar and the following week the market takes out the high.

So as you can see, it's quite an effective technique and the longer term timeframes tend to generate better results. The inside bar pattern is a short-term pattern and should be ideally traded within the trend.

In the next lesson we will continue taking a look at very short-term chart patterns. It's been my pleasure to be with you. Have a great trading week. This is Sandy Jadeja for Cantos Charts Masterclass.