The pin bar trading strategy, is a price action reversal trade setup that can be used to make money from the markets when used correctly. In this lesson we will explain what a pin bar is, and how to use one when you see it in the correct manner to setup profitable trades in the market.
What is a Pin Bar & How Do You Define It?
We all know the story of Pinocchio – the boy whose nose grew longer anytime he told a lie. A pin bar is also called a Pinocchio bar because it is telling us that the market is lying and the length of the pin indicates the elongating nose of Pinocchio.
As the market price moves in the direction of the trend up to a certain level, it suddenly retreats all the way back to near the opening price. Thus, it lied as to where the price was headed.
A pin bar reversal pattern, is made up of a long wick and a small body, which could extend from above or below the body. They are easily identifiable on your charts with a little practice.
The rejection of price direction by traders is what causes price to go back towards the opening price of that candle, indicating that the traders in the previous trend have run out of steam and that counter-trend players have come in.
What Are the Characteristics of A Pin Bar?
Here are some easy to follow rules to identify pin bars on your charts;
- Wick must be at least 3x the length of the body of the candle.
- Wick ideally is similar same size as the previous candle (bigger = better).
- The closing price must be located within the length of the preceding candle (i.e. not gapping).
- A smaller body and longer wicks are preferable
- Body must be on one end of the wick, essentially looking like a mallet or hammer
How To Trade a Pin Bar Setup
The first step is to confirm that the pin bar in question matches the characteristics described above. To do this, the trader must wait until the candle in question has closed. This is the only way the candle can be evaluated to see that it is a true pin bar.
The next step is to make sure that the pin bar has formed at the bottom or top of a trend, ideally at a key support or resistance level. If it forms in a range-bound market, it is rarely of use unless at the range highs or lows.
But if the pin bar forms at the top of a trend and this area corresponds to market resistance, this is a very good setup for a short trade. Similarly, a pin bar which forms at the bottom of a trend at an area of support is a good setup for a long trade.
Fig2a: Long Entry Setup for Bullish Pinbar on Support Level
Entry and Stop Loss Placement
What are the best ways to enter the trade as well as set stop loss and target settings for the trade?
The best bet for an entry is to wait for the open of the next candle to initiate the trade. As much as possible, only enter trades where the pin bar has formed at the support or resistance level so as to strengthen the signal. Use market orders for the trade.
Trade signals that occur on longer term charts tend to be more reliable, but take more time to mature for often the same reward to risk ratio.
One entry method discussed has been the 50% retrace entry, but statistics show this to be a highly inefficient method.
Stop Loss/Take Profit
Place the stop-loss above or below the wick of the candle depending on the time frame chart you have chosen. Part of the reason why this trade is setup using support and resistance levels is so that a trade that moves against the trader will most likely halt its drawdown at the key support/resistance before resuming in the trader’s chosen direction. As such, stop loss levels should be set below the support for long trades, and above the resistance for short trades. The risk management profile for the account as well as the risk-reward ratio will determine the number of pips used as stop loss. Aim for a minimum reward to risk ratio of 1.5:1.
Take Profits should be set as a whole to the nearest key level ahead of the trade. On a daily chart, this could translate into a target of 150 pips for every 100 pips risked. Better reward to risk ratios are seen when the trades are properly screened as follows:
a) Pinbars with long wicks and smaller bodies.
b) Closing price as close to key level of support/resistance as possible.
The pin bar setups should be practiced on a demo account before being applied to a real money trading account. But as a whole, if you can learn to add this price action setup to your arsenal, then you will find yourself making really good reversal trades and high probability setups when you take the price action, setups and context into account.