Trading The Outside Bar (Engulfing) Candlestick Pattern

Among the patterns formed by Japanese candlesticks, there are both rare and frequently occurring ones. Among the latter, and frequently occurring patterns is a combination of two candles called "Outside bar". This pattern can also be found under the name Engulfing (more precisely, a bullish/bearish engulfing).
This one is fairly simple, but gives most of the reliable signals, which are used by traders around the world. So, let's take a closer look at the Outside Bar pattern and the peculiarities of its formation and use.

What is an Outside Bar (Engulfing)?

The "outside bar" or "engulfing" - is often seen on the chart formation of two Japanese candles of a reversal nature, where the body of the latter candle will always be larger than the preceding and completely overlaps it.
In simple words, the outside bar - is two candles, coming one after another, while the body edges of the right (the latter) always go beyond the left candle (as if engulfing it).
 

The outside bar pattern is available for identification only on the charts of Japanese candles. It is a reversal pattern, i.e. it signals an impending reversal of the price movement. Depending on the market movement in which direction the pattern was formed and what color the candles took, we can conclude the subsequent direction of the trend.
Keep in mind that by definition, both candles must have a body, which means that the candle on the left should not be a "doji" (candle without a body, or with a very small body similar to a cross).
The outside bar is also called a pattern called "engulfing" because the size of the body of the second (right) candle always seems to absorb the size of the body of the first (left) candle.
If the candlesticks which form the pattern have shadows, then it's not necessary to have their bodies absorbed, by analogy with the bodies. However, if the engulfing of the shadows still occurs, it will greatly enhance the signal.
The new price movement formed by the reversal after the outside bar pattern is, as a rule, longer and stronger than the preceding one.
This forex pattern is quite reliable and often encountered in the market. Signals are especially strong on the overbought/oversold market.
For the pattern to be considered valid, the following conditions must be met:

• The formation should not have "doji" candles;
• The left candle must be a long or a shortened version;
• The right candle must be long;
• The shadows of both candlesticks must be short, or absent at all.

Since after the appearance of a candlestick pattern, both upward and downward price movements are possible, engulfing is usually subdivided into "bullish" and "bearish".
 

Accordingly, if we use the name outside the bar we have:

• Bullish outside vertical bar (BUOVB);
• Bearish outside vertical bar (BEOVB).

A bullish outside vertical bar (bullish engulfing) is characterized by:

• A downward preceding price movement;
• The first (left) candle of dark color;
• The second (right) candle is of light color.

A bearish outside vertical bar (bearish engulfing) is characterized by:

• An upward preceding price movement;
• The first (left) candle of light color;
• The second (right) candle is of dark color.

The nature of the formation of the pattern "Vertical bar" can be understood by a simple example.
Let's assume that the price of a certain asset is falling. The day comes when trading opens with a gap lower than the previous close. The trading mood changes and many people want to use the price gap and open long positions. Some so many people want to close the gap that the price accelerates upwards, and at the end of the day, the price movement is higher than the previous day's closing quotes. Thus, we got a new candlestick with the body of the previous day's candlestick.
And now let's think: how strong is the new direction if the price moved up by an asset more quickly in one day than in the previous day's movement in an established trend. Obviously, in this case, the bulls have a good chance to beat the bears.

Outside Bar Trading Strategies

It is believed that the outside bar pattern gives signals no matter what the time frame is. At the same time, in low time frames (M5 and M15) there is market noise, so it is recommended to trade by the signals of this pattern in higher time frames.

Generally, there are 2 basic recommendations for trading strategies based on the outside bar pattern:
Trading should be carried out with the help of pending orders. It will allow you to eliminate a part of unprofitable signals;
Rely only on the patterns that are in the zone of important levels. They can be support/resistance, Fibonacci, and even trend lines, anything that indicates the market movement in the direction of the signal of a candlestick pattern.
Keep in mind that pending orders in the downtrend are better placed just below the Low of the outside bar and the Stop Loss is set above the High of the same bar with 4-7 pips offset.
It is advisable to fix profit when the price chart crosses important levels (support/resistance, Gann and Fibonacci lines). Some traders fix profits in parts at different levels or use Trailing Stops.
When trading on the rise a pending order is placed with accuracy, but on the contrary - slightly above the High of the right candle. Stop Loss is placed below Low with an offset of 4-7 points. Fixing of profit is carried out similarly to the above method.
To increase the reliability of the trading strategy focused on the outside bar, many traders confirm the signals of the pattern using the means of technical analysis. Indicators RSI, MACD, Alligator, and many other built-in tools can be a good way to confirm obtained signals.
Also, it is possible to confirm a signal of the candlestick pattern with the analysis of trading volumes. Most likely, on the second (right, engulfing) candle of the reversal formation, we will see a significant increase in the number of trades.
Many traders are used to paying attention first of all to price extremes when evaluating market charts. In this case, candlestick patterns, including the outside bar pattern, may remain unnoticed.
For better identification of the outside bar candlestick pattern, there are special indicators, let's consider one of them.
The Outside Bar indicator was created specifically to identify the candlestick pattern of the same name, that is, an outside bar or engulfing. The algorithm is written for the MetaTrader 4 platform. Indicator settings allow to mark market entry points with arrows, there is a possibility of sound alerts on the appearance of a new pattern. The indicator can work in one or several time frames simultaneously.
When placing the indicator on the chart, blue arrows will highlight "bullish absorption", and red arrows will highlight "bearish". With thick vertical lines the distance between the High and Low of the candle.
The indicator allocates quite a lot of patterns, and most of them are far from ideal. However, using this technical analysis tool is guaranteed not to allow the trader to miss a reliable pattern.

Tips On Identifying and Using An Outside Bar

Even though the outside bar pattern gives reliable signals, there are recommendations to make trading even more efficient:

• Ignore the reversal patterns, which appear in the trend;
• Try to open a position coinciding with the direction of the trend and after the price correction;
• Follow the signals of the patterns that appear in time frames M30 and higher;
• Confirm the signals of the outside bar pattern, using any of the most understandable to you indicators of technical analysis, or the analysis of the volume of trades;
• Trade only those pattern signals that are very close to important levels (support/resistance, trend lines).

It is also worth noting that in the candlestick analysis, there is a concept of "False Outside Bar". This pattern corresponds to all the criteria of the classic engulfing pattern, but the body of the right (the second, engulfing) candle is much larger than the body of the first one.
In this case, the size of such a candle is justified by very strong or unexpected news, a panic mood is formed in the market. As a rule, after the close of such a candle is followed by a strong correction, with the size of at least half of the second candle's body, a false outside bar. You should not expect a trend reversal in this situation.

Conclusion

The outside bar is a frequent and reliable candlestick pattern. It can very likely signal reversal trends in both bull and bear markets.
Many traders are confused about the terminology. In fact, the outside bar and engulfing refer to the same candlestick analysis pattern.
Based on this pattern, it is possible to create an independent trading system. This pattern is sometimes used to incorporate existing strategies, or some traders prefer to check the signals of the candlestick pattern using technical analysis.
In any case, trading systems that take into account the outside bar candlestick pattern have a chance of making a profit.

About AdroFx

Established in 2018, AdroFx is known for its high technology and its ability to deliver high-quality brokerage services in more than 200 countries around the world.  AdroFx makes every effort to keep its customers satisfied and to meet all the trading needs of any trader. With the five types of trading accounts, we have all it takes to fit any traders` needs and styles. The company provides access to 115+ trading instruments, including currencies, metals, stocks, and cryptocurrencies, which make it possible to make the most out of trading on the financial markets. Considering all the above, AdroFx is the perfect variant for anyone who doesn't settle for less than the best.