Price action trading can be a useful technical analysis method that can help you better predict the market and help anticipate potential entry and exit points. Here’s a brief introduction to price action patterns and the top 10 patterns you should master.
What Are Price Action Patterns?
Price action describes how the price of a security moves over time. This concept is the foundation for all forms of technical analysis of commodities, assets and stocks.
Traders can interpret price action through patterns and chart compositions that help them spot trends, interpret data and anticipate reversals and breakouts. These are called price action patterns.
Price action patterns are sometimes used interchangeably with other pattern types, like stock chart patterns.
10 Important Action Patterns to Master
You can spot many types of price action patterns. They generally fall into two wider categories — reversal or volatility bar patterns.
These seven reversal bar patterns and three volatility bar patterns are some of the most important to master.
1. Reversal Bar
Bullish reversal bar patterns go below the previous bar’s low before closing higher. Bearish reversal bar patterns go above the previous bar’s high before closing lower.
With bullish patterns, the stock market has found a support level below the previous bar’s low. The bullish reversal bar also shows that the support level was sturdy enough to nudge the bar to a higher closing position than the previous bar.
These patterns are the first indication of a potential bullish reversal.
With bearish patterns, the stock market was met with resistance above the previous bar’s high. This resistance was also strong enough to cause the bar to have a lower close than the previous bar.
Many traders use reversal bars as indicators of when to buy and sell. During uptrends, they typically buy above the bullish reversal bar. During downtrends, they may sell below the bearish reversal bar. However, these strategies cannot guarantee success.
2. Key Reversal Bar
A key reversal bar is a type of reversal bar that shows more apparent signs of an impending reversal.
Bullish key reversal bars open below the previous bar’s low and close above the previous bar’s high.
Bearish key reversal bars open above the previous bar’s high and close below the previous bar’s low.
Key reversal bars indicate powerful downward thrusts when they show a down gap. This movement happens because the market is likely rejecting bearish energy, indicating a possible reversal to bullish trends.
However, if the gap bumps upward and is met with resistance, this indication could show that the market is turning bearish.
Typically, traders may leverage key reversal bars by buying above the bar if bullish and selling below the bar if bearish. If unsure, they’ll usually wait for the price to close before selling assets, closing above for bullish and below for bearish.
3. Pinocchio Bar
The Pinocchio bar is sometimes called the pin bar. This bar looks like Pinocchio’s nose and is characterized by a long tail.
In bullish markets, the pin bar’s lower tail dominates the bar. In bearish markets, the upper tail dominates the bar.
In bullish markets, some traders will usually buy above when the pin bar is met with rejection from the support level. In bearish markets, they may sell below when the pin bar is met with rejection from the resistance level.
However, pin bars are known to trick traders into heading in the wrong direction by momentarily breaking resistance or support. This indication can trap traders, so it’s important to be cautious about only acting on this indicator and gathering other data points as well before making a decision.
4. Exhaustion Bar
The exhaustion bar opens with gaps either up or down. In bullish markets, the gap is down and works its way in an upward trend to close near its top. In bearish markets, the gap is up, then moves down for the close.
A key identifier with exhaustion bars is that the gap stays unfulfilled.
In theory, traders will usually buy above when the exhaustion bar is bullish and sell below when the bar is bearish.
The exhaustion bar is aptly named because it indicates the exhaustion of one side of the market. When the bears are exhausted, the bulls move the market up. When the bulls are exhausted, the bears move the market down.
5. Three-Bar Pullback
The three-bar pullback is an easily identifiable bar pattern made of three consecutive bars.
When the consecutive bars are bearish, the pullback pattern is bullish. When the consecutive bars are bullish, the pullback pattern is bearish.
During a bull market, some traders may wait for the three bearish bars. Once those consecutive bars pass, they look to buy above the subsequent bullish bar.
During a bear market, they may wait for the three bullish bars. Once they pass, traders may look to sell below the subsequent bearish bar.
When the market is experiencing a strong trend, counter-trend pullbacks are hard to sustain. That is why some traders wait for the three-bar pullback; after the pullback, the trend could likely resume.
6. Two-Bar Reversal
The two-bar reversal is characterized by two bars that close in opposing directions.
In a bullish two-bar reversal variant, the strong bearish bar is subsequently followed by a bullish bar. In a bearish two-bar reversal variant, the opposite is true.
In bullish cases, traders will typically buy above the two-bar pattern’s highest point; in bearish cases, they’ll sell below the pattern’s lowest point.
The reversal pattern operates on the premise that a clear rejection of one variant will be followed by a reversal in the opposite direction.
7. Three-Bar Reversal
Like other price action patterns, three-bar reversals have bullish and bearish variants.
A bullish three-bar reversal has the following in sequence:
- A bearish bar
- A bar with a lower low and lower high
- A bullish bar with a higher low that closes above the previous bar’s high
A bearish three-bar reversal has the following in sequence:
- A bullish bar
- A bar with a higher low and higher high
- A bearish bar with a lower high that closes below the previous bar’s low
As a result, some traders will usually buy above the third bar in a bullish pattern and sell below the third bar in a bearish pattern.
The three-bar reversal can indicate a turning point in the market.
The NR7 is a volatility bar pattern made up of seven bars. The last bar in the pattern has the smallest range of the entire sequence.
If the trend is up, traders typically attempt to buy a breakout of the last bar’s high. If the trend is down, they may sell a breakout of the last bar’s low.
The NR7 signals a price thrust characterized by decreased volatility.
9. Inside Bar
With the inside bar pattern, the second bar stays entirely within the range of the immediately preceding bar. The inside bar has a higher low and a lower high.
When trading consider these potential factors:
- Some investors may place bracket orders around the inside bar pattern so they can trade the breakout, no matter the direction.
- If a buy stop order is placed above the bar’s high, then a sell stop order may be placed below the bar’s low. That way, if one order is triggered, the other order can be canceled.
- Generally, some investors may only want to place one order, whether it is buy or sell.
- Wait for the inside bar to potentially break out, then trade the failure.
Inside bars signal volatility. They demonstrate a lapse in price action but don’t show a strong indication in either direction.
10. Outside Bar
The outside bar is the converse of the inside bar; the range of the second bar exceeds the immediately preceding bar, with a lower low and a higher high.
Outside bars are short-term increases in volatility and show strength in both directions.
Combine Patterns or Expand Your Trading Strategies
Price action is subjective since any two traders can arrive at two completely different conclusions when looking at the same price action. Where one trader sees a downtrend, the other may see a potential turnaround. That’s why price actions on their own don’t make you a profitable trader.
Nonetheless, price action itself is a source of helpful data that lends to other tools used to interpret indications in the stock market. Price action patterns can become even more effective when they’re combined to help inform trading tactics.
You can see these benefits when you combine a pin bar with an inside bar, for example. This combo pattern helps you identify a pin bar that is followed immediately by an inside bar, which can be used to find potential opportunities when trading on a daily chart.
Pro Traders Typically Study Price Action Patterns
If you want to be like a pro trader, consider studying price action patterns. While these patterns are not hard science, they are useful indicators that can help improve your trading choices.
Frequently Asked Questions
Which indicator is best for price action?
No single tool is best for interpreting price action. It’s wise to combine tools like price action patterns and stock chart patterns when performing technical analysis.
How reliable is price action?
Price action is not meant to be used on its own; instead, it should be used in tandem with other methods. Although it is a helpful tool, technical analysis is not a hard science. While price action is informative, it should not be your only basis for trading strategies.
Which timeframe is better for price action trading?
Price action trading is generally done in the short term.