Price Action Forex Piercing Pattern & Outside Candles

In the current environment with the Euro getting punished across the board against every major currency and likely even the Iraqi Dinar, as traders we want to be taking advantage of these environments by getting short and staying short. However, there are times when the short term moves day traders like to take advantage of in these strong sell-offs communicate something different that we do not want to keep adding on shorts to a current downtrend or move. This is often found two simple price action formations called the ‘Piercing‘ & ‘Outside‘ formations. We will go over both so you can recognize them, learn what they mean from a price action perspective and how to relate or trade them. The Piercing Candle This is a simple two candle setup that is probably best applied to nothing less than 1hr time frames and ideally higher. The higher you go, the stronger it will be.  Below is a traditional example of a Piercing Candle. The way the formation works is we have to be in an established trend (either up or down). We will call this two candle formation an AB formation meaning there is an A candle (first) and a B candle (second). In this AB formation, the A candle is in the direction of the trend and is generally strong, one of the stronger or larger candles in the current trend. It could be large for two reasons; 1) Market is heavily participating in the trend 2) The market is giving one last push possibly before short covering (or long covering depending upon the direction of the trend) and taking profits The institutionals usually like to give a really strong push before giving up a trend. An example of a piercing candle is in the chart below. As you can see from the chart above, we clearly have a strong downtrend on the EURGBP. This is the 2hr chart and notice how at the end of the move, the A candle is quite large but is countered by a very strong blue candle. This AB formation meets the first two requirements being that; a) we have to be in a clear trend and b) the A candle has to be strong or large (ideally one of the larger ones in the move). We will address another reason why it helps for the A candle to be large soon. Another requirement of the piercing formation is that the B candle ‘pierces’ a minimum of 50% into the previous candle. The more the better but it cannot engulf it which is another pattern. The max. it could pierce into the A candle is 99% for it to remain a piercing pattern. Why is the 50% the line in the sand? The reason why is anytime you have a strong downtrend, you have one side of the market clearly in control. For a really strong with-trend candle to be followed up and reversed minimally 50% or more by the next candle suggests it has the strength to counter the already existing momentum. This signifies strength to stop a moving force and reject it by 50% or more. Once it closes 50% or higher, it becomes a piercing pattern. When we see these, its no longer a good idea to keep selling or trading in the direction of the trend until the coming reversal shows signs of weakening and the trend will likely resume. Below is the follow up candle to the AB piercing pattern. It is very common to see a strong follow up candle to a piercing pattern and this confirms its validity. Thus, it is very good to be able to spot these patterns, especially if you are trading a strong downtrend and adding onto the position as it continues to advance. If you feel the trend is going to continue, one technique could be to wait for the pullback to reach a 20ema on the 2hr or 4hr time frame. If price stops here and then forms another reversal candle, then you can start to look for with-trend setups. You can also check out my article on the with-trend failure setups using the 20ema for another technique as well. One other technique to get back in the trend is wait for a break of the lowest low or highest high from where the piercing formation was. A break of this level means whoever countered the trend has given up all the ground they made and are now losing money and the trend is likely to continue. Either way, being aware of these formations on the 1hr, 4hr, or daily time frames can alert you to take profits on your trend trades and wait for another setup. Outside Reversal This is another price action formation that you need to be aware of if you are trading trends and are wanting to know when to take profits and get out. Remember trends can go much farther than you think so having fixed targets or parameters for getting out of them is not always advised. It is better to wait for price to confirm the trend is ending before you get out and the Outside Reversal formation can often signal such. Taking a look at the same pair but on the 4hr time frame, we can see from the chart below the downtrend is met by a very large candle which engulfs or the price action is completely outside the previous candle. This formation is also an AB formation whereby the A candle is also like the piercing, a large candle, yet the B candles’ price action is ‘outside‘ meaning the wicks and ideally body of the B candle are both higher and lower then the highs and lows of the A candle. See chart below. The same mentality applies with this and the piercing pattern, meaning when we see such a strong rejection without any hesitation, stalling, or bottoming formation, we have to pay serious attention to it and make sure to take profits when trading the trend and this formation shows up. Notice how the A candle at the end there is the largest in the last swing down, but is completely taken out by the B candle. To stop the trend momentum so forcefully and take out all the gains means the order flow changed hands real fast and control has been taken by the other side. We have to take profits on this and then wait for another setup to get back in the trend or look to see if its going to start a full on reversal of the trend. Another example of this formation is in the chart below. Look at how long this trend has been active with the euro losing 1700 pips to the kiwi. Then out of nowhere the pair reverses course with a huge outside formation and follows it up with another upcandle. All the other blue candles were not game changers for this trend, however this outside formation in two candle climbed 300+pips of the 1700 = 17.5% reversal of all the gains. You can bet any institutional traders short who just watched 17.5% of their gains get wiped out in 8hrs after being short for over 20days will take profits or even exit all together. Thus it becomes critical to be able to spot these formations when trend trading. This is crucial because environments like these where one currency (the euro) is suffering against everything across the board gives traders really good environments to make a lot of money in a concentrated period of time. These are times where the best traders like Jesse Livermore and Richard Wyckoff would die for and make large amounts of money just trading these environments. In some sense, it totally makes sense because the direction is easy to call and we just have to get in and stay in to make the money on these trends. Learning how to do this can often bring about a month or two worth of gains in a matter of a few trades. However, we have to be aware of the price action formations which undermine these moves and tell us to take profits. If you would like to learn how to spot these price action formations to where they will just pop out of the charts, then check out our Price Action Course where you will learn high-probability rule-based systems to take advantage of such moves. If you want to learn how to get into trends and take 80% of the move, then check out our ProForex or Advanced Ichimoku Courses.

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Discussion

22 Comments

  • Ben - October 3, 2011 4:45 pm

    Hey Chris,

    couple questions about this article…

    1. Piercing candles are for downtrend reversals only, correct?
    2. What is significant about the opening price of a piercing candle? That is, where does the candle need to open relative to the preceding candle to be considered a piercing candle. (just asking about the opening price, your article was clear on where it needs to close to be considered piercing)

    Thanks!

    • Chris Capre - October 3, 2011 4:59 pm

      Hello Ben,

      Good questions…according to the classic candlestick principles, a piercing candle would only be for a bullish reversal so yes. The bearish reversal of this formation is referred to as a ‘dark cloud cover’

      In regards to the second question, the open could be a gap down or subtle gap up along with an open exactly in line with the previous close. Keep in mind, if it does gap up, it should not pierce the 50% mark of the previous body.

      Some other subtle points to consider;
      1) if the formation happens near a key support level it strengthens the signal
      2) the stronger the piercing into the prior bars body, the better the signal as well which indicates greater force
      3) as a general guideline, this formation can occur after medium strength moves around 6-12 candles of an impulsive move in one direction but for longer term trends reaching over 20+ candles this often is not the reversal signal you will see but could indicate a solid pullback, perhaps to the 20ema.

      Hope this helps
      Chris Capre

  • Patricia Liu - October 12, 2011 8:37 pm

    Hi Chris,

    great material as usual. Question, for the “piercing pattern”, does the low of candle B have to be lower than the low the candle A ? if the low of candle B is higher than the low of candle A, is it still a valid piercing pattern ?

    thanks,
    Patricia

    • Chris Capre - October 13, 2011 3:00 am

      Hello Patricia,

      Great question. The low of candle B does not have to be lower than candle A. It could be the same as candle A and still be a valid piercing pattern so good question. The low of candle B can also be higher (as in a gap up) than candle A so this is an acceptable piercing pattern as well but think about the nature of the piercing pattern and this will tell you that candle B’s low should not be much higher than candle A’s low.

      Let me know if this makes sense.

      Kind Regards,
      Chris

  • Patricia Liu - October 13, 2011 7:39 pm

    Hola Chris,

    Thanks for the answers. Do you have rule based systems for these 2 patterns ?

    Gracias,

    Patricia

    • Chris Capre - October 13, 2011 11:34 pm

      Hello Patricia,

      We are actually testing them with our algorithms to see if there is a quantitative way to trade them so will update you soon. If so, we will add them to the Price Action Course for sure.

      Kind Regards,
      Chris

  • Patricia Liu - October 16, 2011 8:58 pm

    Hi Chris,

    do the “dark cloud cover” pattern and the outside reversal candle on the top of an up trend have the same impact/significance ?

    thanks,
    Patricia

    • Chris Capre - October 17, 2011 1:34 am

      Hello Patricia,

      A Dark Cloud Cover pattern is a little different than an outside candle if you look at the two formations. The outside has the price action which is completely outside the previous day’s candle, ideally both the body and the wick and thus communicates more strength (to some degree) in the reversal because it doesn’t just pierce the previous candle but completely takes it out, and thus has taken out the previous gains/losses so there is a critical difference here.

      Does this make sense on how it is different?

      Kind Regards,
      Chris

  • Amis - November 16, 2011 7:16 am

    Hello Chris,

    This is one of the reply which you had given earlier to one of the comment.Does it apply for the “outside side reversal Pattern” also??and those 20+ candles you mention below are only of a impulsive move or mixture of impulsive and corrective??
    “As a general guideline, this formation can occur after medium strength moves around 6-12 candles of an impulsive move in one direction but for longer term trends reaching over 20+ candles this often is not the reversal signal you will see but could indicate a solid pullback, perhaps to the 20ema.”

    Thanks

    Amey Sawant

  • Chris Capre - November 16, 2011 7:28 am

    Hello Amis,

    I would not apply this same logic to the outside reversal pattern. The 20+ candles are in reference to a trending move so more impulsive than corrective.

    Hope this helps
    Chris Capre

  • Amis - November 16, 2011 9:36 am

    Hello Chris,

    Thanks for the reply.From what you said,the example or chart(EUR/GBP)which you have used for piercing candle pattern above is not a reversal then as it has more then 20+ candles.Is it?

    Thanks

    Amey Sawant

    • Chris Capre - November 16, 2011 10:00 am

      I think you misunderstood what I was saying. This does not have to do with the signal itself which could produce a short term reversal to the 20ema which I mentioned in the quote. It often does not produce a major reversal of the trend.

      Hope this helps
      Chris Capre

  • Patricia - November 29, 2011 12:38 am

    Hi Chris,

    when you say “the B candle ‘pierces’ a minimum of 50% into the previous candle.”, does that mean 50% of all the previous candle including wicks or 50% of the body of the previous candle?

    Also, if B candle’s upper wick is higher than A candle’s upper wick but B candle meets the other criteria, is it still a valid “piercing pattern”?

    thanks,
    Patricia

    • Chris Capre - November 29, 2011 4:14 am

      Hello Patricia,

      I tend to include 50% of the wicks as well because the body could be quite small.

      If B’s wick is higher than A’s, then it would not be a piercing pattern.

      Good to hear from you again.

      Shall we do a skype call soon to go over trading before the year ends?

      Kind Regards
      Chris

  • Amis - April 25, 2012 3:13 am

    Hello Chris,
    Could you please explain the difference between “outside Reversal” and “engulfing” candles ?
    It will be great if you explain it considering the above examples for “outside outside Reversal Candles”

    Thanks

    Amis

  • Paul - July 10, 2012 3:24 pm

    Hi Chris What would the following pattern be called in an AB bar formation? The bars have no wicks for simplicity’s sake. In an uptrend the B bar opens below the high/close of the A bar(previous bar), and closes below its open/low. In other words the B bar is seen as a lower high and a lower low on the chart. Is it a variation of an engulfing or outside bar pattern. Or called something els entirely. Thank you in advance.
    Best Paul

    • Chris Capre - July 11, 2012 12:07 pm

      Hello Paul,

      Hmm, not sure I understand it so perhaps you can send me a screenshot of it to my main email address so I can see it visually.

      Thanks in advance.

      Kind Regards,
      Chris

  • samuel - October 4, 2012 1:38 pm

    waaaooh!! this is fantastic. i’ve actually used this today and am amazed. thank you. will save for the price action course most definitley.

    • Chris Capre - October 4, 2012 1:50 pm

      Hello Samuel,

      Yes, its a highly effective technique when you learn how to use it in the right circumstances
      many of my students have been using this as well.

      But looking forward to working with you.

      Kind Regards,
      Chris

  • Mohammad Hannan - May 4, 2013 12:33 pm

    Hello Sir, Today I have seen on USDCHF, H1 chart. At the end of the chart there are two long candles A-black and B-White. under the B , there is other white candle which has a long tail. Is it the PIN BAR candle?

    • Chris Capre - May 4, 2013 12:38 pm

      Hello Mohammad,

      There is no way for me to know unless I can see the chart, as its possible with price feeds, and other broker differences, the candle might look different.

      So email me and I’ll take a look.

      But post the image on my 2ndSkiesForex Facebook page, and I’ll take a look.

      Kind Regards,
      Chris Capre