One of the better trading strategies for beginners are volatility breakouts. There are three reasons why they’re good.
Firstly, you can place a tight stop, therefore reducing risk.
Secondly, the range expansion that comes on a successful breakout can be huge, compared to the risk taken.
Thirdly, they occur regularly on all markets.
The low volatility to high volatility cycle is one of the more predictable cycle in the market, and dare I say it the most profitable.
There are a number of ways to trade volatility breakouts. Read on, and I’ll explain my favourite, something I’ve called the Harami Inside Bar
The standard inside bar
An inside bar is a very common two-bar pattern occurring on most markets and timeframes.
In this pattern, the most recently closed bar has a lower high and a higher low than the previous, or mother bar.
Standard inside bars are useful for trading, but the effectiveness of the pattern increases dramatically when a harami is present within the pattern.
The Harami Inside Bar
With the Harami Inside Bar, there are two criteria needed:
- the inside bar
- the harami
This can be seen in the diagram below.
Why it works
The volatility cycle is the most important cycle in the market – low volatility begets high volatility. It’s a cycle that’s repeated across all markets and timeframes.
The Harami Inside Bar is a great way of representing this reduction in market volatility.
On a much lower timeframe, HIBs are usually triangle or wedge patterns.
Triangles and wedges are traditional chart patterns with a high degree of accuracy.
In these patterns, trendlines are drawn connecting lower highs and higher lows, until the very apex of the pattern, price volatility spikes in one direction, often violently.
The Harami Inside Bar is really just another way of representing a triangle or wedge, but on a higher timeframe, and without the need to draw trendlines on the upper and lower boundaries.
Harami Inside Bar trading rules
- The latest bar must have a lower high and a higher low than the previous bar
- The latest bar must have an open to close (real body) contained within the open to close (read body) of the previous bar
- Place a buy stop order two pips above the high of the latest bar
- Place a stop loss at the low of the latest bar
- If not triggered within one bar cancel the order
Once in a trade, it’s vital to know when to get out.
There are many exit techniques for a trader to choose from.
But the one I’ve found most effective for short-term trading is trailing a stop at the low of the latest bar when long. Or, trailing it the latest high if short.
This gives you the juice of any significant price move but will also have you taking profits at the first sign of trouble.
Looking at the visual below, you can see in action how this works.
Harami Inside Bars signal potential explosions in price. The setup is a double whammy in constricting price volatility.
Reduced volatility in high and low prices, the inside bar
But also, reduced volatility in open to close prices, the harami.
Added together they make can make a potent mix.
This system works well on 8-hour, daily and weekly price charts.
They’re easy to recognise, simple to trade and are therefore are an ideal strategy for the neophyte trader.