Strong Technical Signals and What They Mean to Traders (Part 2)

A sound working knowledge and understanding of these signals will help the trader develop a well-rounded arsenal of trading tools. These will perform well in both trending and non-trending markets. So use the insights you will find here, but be sure to heed our earlier advice:!  Take a slow and methodical approach when learning new trading tools and techniques such as these. You can trade strong technical signals like these for your entire career. Whatever you do, do not rush to put these or any method into play before you've become fully knowledgeable and proficient.   

Strong Technical Signals: The Smash Bar

By definition, a smash bar is a sign of exhaustion that occurs at known price extremities. It will often signal a high-probability reversal trading opportunity. But there are a couple of important distinctions to know about smash bars right up front:

• These strong technical signals are significantly more useful for trading range bound markets than trending ones. This is particularly the case when price "smashes" up against an extremity such as a multi-year or all-time high or low.

• You may think smash bars (see examples below) look quite familiar. There is a good reason for that: A smash bar is identical to a pin bar in its construction. However, it is said to be "counterintuitive" in that a bearish smash bar would otherwise be classified as a bullish pin bar. Indeed a bullish smash bar is, technically speaking, a bearish pin bar.

What Does a Smash Bar Formation Look Like?

It would be fair to say that the smash bar gets its distinctive name because the bar itself—not the candle's "wick," mind you—is being "smashed" up against a key price extremity. like a 2-year or 5-year range boundary, or perhaps even an all-time high or low.

It is actually this price relationship that qualifies a smash bar. If the opening or closing price did not interact precisely with the price extremity, then we might simply have a classic pin bar.

Notice also how price action during the bar's lifespan does manage to surpass the key support or resistance level. But its failure to sustain that price into the close is what signals capitulation, or a reversal in momentum between bulls and bears. And that's what creates the worthwhile trading opportunity we'll discuss in just a moment.

What Does a Smash Bar Tell about Price Action?

Regardless of their colour (green or red), smash bars represent strong technical signals. They favour a high-probability reversal trading opportunity starting as soon as the next bar. And here's why:

The pin bar nature of the candle body, coupled with the relatively wide price range represented by the wick, indicates a disappearance of either the bulls needed to take out resistance overhead (bearish smash bar) or bears needed to break through key support (bullish smash bar).

Do keep in mind the "counterintuitive" nature of smash bars, however. Once again, were it not a smash bar closing directly on or very close to key support/resistance, the candle might otherwise signal a trend continuation, not a reversal, and we'd trade it differently.

Regardless, our smash bar trading strategy utilises the candle itself to plan and execute the trade. We are only triggered into the trade once the subsequent price action provides confirmation. This happens when the reversal formally occurs, the trader gains a degree of protection and confidence in the position.

How to Use a Smash Bar as a Trade Signal

We trade smash bars exactly the same way we do pin bar reversals. This is in regards to entry, stop loss and target placement, and risk management. We keep in mind of course, that a bearish pin bar is taken in this case as a buy signal, and vice versa. So the rules for trading are as follows:

Shown graphically, this strategy would be as follows:

Please note that smash bars should be traded end of day only. Just like with any risk-minded trading strategy, no single trade should risk more than 1-2% of available account capital. In addition, once triggered into a smash-bar-inspired trade, we recommend using a trailing stop to preserve profits and guard against downside risk. To do so, trail a stop just below the low of every second buyer bar (if long), and just above the high of every second seller bar (if short).

Conclusion

This 2 part article set is designed to introduce you to the various concepts of technical trading. If you want to learn more, then you can look at other specific set ups such as engulfing candles. You should remember that technical trading is a high risk exercise as many brokers will warn you in the banner of their welcome page.