From the March 2013 issue of Futures Magazine • Subscribe!

Targeting entries with inside price bars

Sushi roll

Inside price bars can be used alone as a reliable method of anticipating trends or confirming support and resistance in the market, but they also can be used in combinations to identify key trading opportunities.

One important characteristic of inside bars is that they reflect lower volatility, typically following strong price movement. This could have a number of causes. New information may have been introduced to the market that impacts current prospects or future price expectations. This sentiment could spread, and the former zeal behind the earlier move could wane. However, often that zeal rests just below the surface, and it doesn’t take much to kickstart a new surge in price and volatility.

This can happen all at once or over the course of several days. In either case, inside bar patterns can clue you in to pending opportunity (see “Reversal play,” below). One of these patterns is known as the Sushi Roll. This is a multiple-period formation consisting of 10 bars where the first five are inside bars, falling within a narrow range of highs and lows, and the next five are outside bars that contain the first five. The name of the pattern was coined by Mark Fisher, trader and author of the book “The Logical Trader.”

The major benefit of this pattern is that it signals a potential price reversal much sooner than chart patterns such as a double bottom or head-and-shoulders formation. Plus, it’s applicable to any time frame, so it can be customized depending on your own trading preference.

To that end, it is important to note that the 10-price-bar rule is not set in stone. What is important is the underlying principle that any price range that trades in a small range followed by expanding price action makes a strong case for a price reversal. This knowledge alone can help you avoid unnecessary losses by tightening up your stops, taking profits or exiting the trade altogether.

The strategy can be adopted for larger time frames by conservative traders simply by increasing the number of days to watch for market reversals. Increasing the day range to as many as 20, for example, can help you avoid false moves compared to using the 10-day pattern. While you sacrifice getting into a market reversal earlier and lose some of the early profit potential, the trade-off is that you can catch trends that have the potential of lasting for years.

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