Forex price action trading as a whole should be interpreted as “getting into a position with the highest chances to make a profit”. The market can be unpredictable, and the best we can do is to shift the odds as much as possible on our side, trying to limit losses and increase profits.
There are many models of price action that help us to move the balance of probabilities on our side and one of them is called Pin Bar (from “Pinocchio” because the candle has a long nose that lies to the direction of the price). Some other names would be to find it as the Hammer (bullish) and Shooting Star(bearish), which is nothing but a pattern formed by a single candle with some specifics technical characteristics.
As we can see from the image, the main feature of the Pin Bar is to have a very small body and a very long shadow, with the closing and the opening very close to the top of the candle itself. This pattern can be realized with any time frame, from 5 minute candles to weekly ones.
But let’s see what the other characteristics of a technically perfect Pin Bar are:
- The shadow should be at least twice the body;
- The body should be within the candle that precedes it and ideally the one following it
- Even better if the body is of opposite sign compared to the previous one, so for example: red previous candle and green Pin Bar, or, on the contrary for the bearish version: green previous candle and red Pin Bar;
- The shadow must necessarily be out of the “traffic” of the surrounding candles, it has to visually exit or be above/below in respect to the other candles that precede it and follow it.
Here is a graphic example of Pin Bars on the EurGbp cross.
Pin Bars for the EurGbp are a fairly common pattern that gives traders the opportunity to get very profitable trades. The period from June to August 2011 saw six signals within a trading range market. As we can see, each graphically marked Pin Bar met all the above mentioned requirements and has always favored a strong movement of volatility and trend reversal.
As we can see from the graph, the Pin Bar is an excellent trend reversal pattern (better if used in combination with an exhaustion bar, or of a correction within a primary trend). You can also strengthen the pin bar signal if combined with significant levels of resistance / support as moving averages, event areas, Fibonacci retracements, etc. …
But now a fundamental distinction has to be made.
The first Pin Bar on the EurPln graph is actually a reversal one, i.e. reverses the medium term trend from a bullish one to a bearish one. The other two Pin Bars are the continuation of the bearish trend in the medium term (just started with Pin Bar 1) and they only reverse the short-term trend.
The latter continuation Pin Bars, are by far the best, as they provide trading signals with a high chance of success in the direction of the main trend, thus minimizing the risk of loss on the trade itself.
Let’s now try to understand what a Pin Bar exactly means from an Order Flow Perspective.
The pin bar by itself explains to us how the operators or institutional traders have tried to push the market in one direction during the trading session, but they did not succeed because other large players have pushed in the opposite direction, thus creating a long shadow. This is the reason why the signal is a reversal one.
In the first chart of EurGbp, we were able to notice how the operation has to be placed when we formalize the Pin Bar itself. But for now we’re going to analyze more in detail how to trade with a Pin Bar and how to handle the position.
Once the candle is formed, we can manage it in different ways. The simplest one is to place a pending order when the top of the candle is violated (for a bullish hammer) or the bottom of the candle is violated (for a bearish shooting star). Another method is to get in on a 50% retracement of the pin bar itself.
Between September and October 2011, the UsdMxn offered two opportunities for traders to enter, and this was due to the formation of two Pin Bars, quite visible on the graph. It should be noted as the first stop loss was not violated by the second Pin Bar and this has allowed long term traders to strengthen the short position of UsdMxn with a new low risk trade.
An alternative method as suggested above is to wait for a retracement of the price up to (more or less) 50% of the Pin Bar.
This second method improves the risk / reward ratio, although obviously, it occurs less often. But there are several methods for trading the price action pin bar pattern which can increase your profitability while reducing risk using rule based systems.