One rule for trading that I use is never be on the wrong side of an engulfing bar.

They are hazardous to your account.

On the other side of the coin, they can be very effective for entry criteria.

The importance of engulfing bars gains if it comes after a directional move.

For this bar to occur it must reverse the previous move from a new high and close below the low of the previous candle.

This requires a significant change in value perspective.

Engulfing bars.jpg (165.02 kb)

Anatomy of downside moves.

I thought it would be worth looking at the Dax 5 min chart on Friday and the SPI 5 min chart today.

Both had downside moves with the structure showing similarities which could be exploited when timing trades.

Trading inside bars that fail can help in capturing these momentum moves.

The move down in both cases was steep with little or no retracement until a large volume bar printed in both cases.

I call these exhaustion bars with a wide range and large volume signaling forced selling in the market.

These bars signal a potential short term momentum slowdown as buyers and sellers move to a more equal balance.

In many cases after a bounce, price retests these lows giving a gauge of directional strength.

In each of these examples price moved to new lows showing that buyers have only slowed downside momentum.

The new lows are showing less volume than the exhaustion bars but more than the retracement bars.

As the day progresses selling dissipates and we see higher lows form, setting up potential for buyers to take control.

Points to take away from these trend days.

Failed inside bars can be efficient momentum entries.

Look for exhaustion bars to halt the momentum.

Expect a retracement in the short term reaction.

Watch for a retest of the exhaustion lows.

Gauge how strong sellers are by the strength of the retest. (new lows show strength in sellers, higher lows show buyers getting the ascendancy)

Look for reversal bars which coincide with higher lows to time reversal trades.

SPI 5min exhaustion.jpg (125.59 kb)                            

Dax 5min exhaustion.jpg (117.93 kb)

Lets look at yesterday's trade on the Dax.

The major trend moves came off multi bar highs and lows.

I have found this to be consistent behavior.

This type of price movement suggests that trends the majority of the time do not start from the middle of tight congestion.

Price tends to wash out either the buyers or sellers before trending.

The price trends down are marked with an orange line.

The price trends up are marked with a green line.

Note that the trends started after failed expansion bars.

We can use information through study to formulate trading strategies.

Dax trends.jpg (124.67 kb)

Reversal moves are often initiated after a failed new high or new low.

I call these "probes".

This gives me the first clues that some traders are caught in losing positions and will have to cover forcing a move in the opposite direction.

The Dax today had a few occurrences on the 5 min chart.

We can separate these into 2 types of failures.

One is a failed test of highs or lows at an exhaustion point.

The other is as price looks to be rolling over but quickly reverses.

Not only can we use these as potential setups but if we are in a position and this type of pattern sets up against us we can recognise it and close out quickly or reverse our position.

I

Dax14-9.jpg (136.02 kb)