The inside bar pattern occurs regularly in financial markets. Incorporating the inside bar strategy into a trading system can enhance a trader’s market analysis technique.
What is an Inside Bar?
The inside bar is a popular reversal/continuation candle formation that requires only two candles to form. This pattern is a direct play on short-term market sentiment, aiming to enter before potential ‘big moves’ in the market. The inside bar indicates a reluctance of prices to progress above or below the preceding candle’s high and low, signaling market indecision.
How to Identify an Inside Bar on Forex Charts
The following steps can help identify the inside bar pattern on forex charts:
1. Identify a Preceding Trend: Use price action or technical indicators to establish the current trend.
2. Locate the Inside Bar Pattern: Identify the inside bar, where the entire candle is fully engulfed by the preceding candle’s high and low.
Trading with the Inside Bar Candlestick Pattern: Top Tips and Strategies
Some traders view the inside bar as a continuation pattern, though a breakout in the opposite direction is also possible. After the price has trended up (or down) for an extended period, the pause in movement (represented by the inside bar) can precede a trend reversal. Therefore, traders often use the inside bar for short-term trades (or swing trading) in the counter-trend direction, typically holding the trade for less than 10 bars.
Alternatively, there is another approach to trading inside bars, based on what the candle pattern does NOT reveal. When traders see an inside bar pattern form, it is interpreted as the market’s reluctance to push the price higher or lower. This hesitation can stem from various reasons:
• An important report is about to be released.
• The market has recently made a significant move, and traders are cautious about pushing prices further.
Regardless of the reason, the motive is the same: traders are anticipating potential volatility to increase profitability. The inside bar pattern suggests that the market is waiting before making its next big move, indicating potential opportunities for traders.
1) Inside Bar Breakout Strategy
As mentioned, the inside bar represents a period of short-term consolidation with low volatility in a trending market. Traders look to trade breakouts once a new high or low is formed.
In the EUR/GBP chart below, the preceding trend is marked by lower lows and lower highs. The breakout occurs below the low of the ‘preceding bar,’ triggering a short entry into the market. If this breakout had occurred above the high of the ‘preceding bar,’ it could signal a long (buy) entry, indicating a potential trend reversal. Trading against the trend carries more risk, so traders should exercise greater caution.
Stop levels can be set at the previous swing high/low (depending on the trend) as dictated by key price action levels. Using the stop as a benchmark, traders can expand this distance by a factor of two to set the take profit (limit) level, creating a 1:2 risk-reward ratio in line with sound risk management. Fibonacci extensions can also be utilized as a limit forecast.
How Reliable is the Inside Bar Candle?
Inside bars can signal continuation or reversals, making this trading pattern more complex. False breakouts can occur, reducing the reliability of the inside bar as a standalone pattern. For this reason, traders often use the inside bar as part of a broader forex trading strategy, with the strategy serving as the foundation and the inside bar acting as a prompt.
Advantages and Disadvantages of the Inside Bar Pattern
| Advantages | Disadvantages |
|---|---|
| Occurs frequently within financial markets | Can signify reversal or continuation patterns |
| Opportunity for favourable risk-reward ratios | |
| Inside bars are easy to identify for novice traders |
