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Inside Bars (And How to Trade Them)

Inside Bars (And How to Trade Them)

James Stanley, Senior Strategist

Inside Bars (And How to Trade Them)

In recent price action articles, we’ve looked at various methods of grading trends, identifying support and resistance, as well as looking for potential entries based on individual candle formations.

The Inside Bar formation can help us find potential trading ideas; and it’s largely because of what the candle is telling us.

What is an Inside Bar?

The ‘Inside Bar,’ is a popular candle formation that only requires two candles to present itself; as this is a play on short-term market sentiment looking to enter before the ‘big moves,’ that may take place in the market.

An ‘Inside Bar’ is characterized by the inside candle’s price action being completely covered from price action the day before.

When we see an inside bar form on our charts, we are seeing a high price and a low price that is inside of the high and low of the day before. This can be looked at as trader’s unwillingness to push price higher or lower for any number of reasons: Perhaps an extremely pertinent report is being issued soon, or perhaps the market had just made a stratospheric leap and traders are tepid about bidding price much higher or lower.

Whatever the reason, the motive is the same: and that motive is looking for potential volatility in an effort to gleam profit. And when we have a situation in which traders are unwilling to bid price higher or lower, we have a potential situation we can look at for future increases in volatility.

The chart below illustrates a textbook ‘Inside Bar.’

Inside_Bars_and_How_to_trade_them_body_Picture_1.png, Inside Bars (And How to Trade Them)

Created with Marketscope/Trading Station

How to Trade Them

Some traders look to trade inside bars as reversal patterns; hypothesizing that after price has trended up (or down) for an extended period of time – the ‘pause’ in price’s movement (representing the inside bar) precedes a reversal of the trend. In this mannerism, the inside bar is looked at for a short-term trade (or swing) in the counter-trend direction (with the goal of holding the trade for less than 10 bars).

So, what is it that this candle is NOT telling us?

It’s telling us that traders are not bidding price higher or lower; that traders are waiting before making the next big move in the asset: And to traders, that means opportunity.

The Inside Bar Breakout

When faced with an inside bar, many traders are looking to trade Breakouts.

Taking the Inside Bar we looked at earlier, we can look to place an OCO (One-Cancels-Other) order on the currency pair – looking to buy the high (if broken) and sell the low (if broken) through entry orders.

The chart below will illustrate the Inside Bar Breakout being applied to the chart we had looked at earlier.

Inside_Bars_and_How_to_trade_them_body_Picture_2.png, Inside Bars (And How to Trade Them)

Created with Marketscope/Trading Station

As the above chart shows, traders can play the Inside Bar Breakout by placing entry orders accordingly; an order to sell slightly below the low price seen leading into the Inside Bar, and an order to buy slightly above the high of the bar previous to the inside candle.

Traders are looking for volatility to increase; with either the previous high or low being broken so that our strategy can initiate its’ entry.

As you can see from the chart below, Inside Bars can lead into extended moves; offering traders a very comfortable spot to enter in the middle of the trend.

Inside_Bars_and_How_to_trade_them_body_Picture_3.png, Inside Bars (And How to Trade Them)

Created with Marketscope/Trading Station

Is every Inside Bar going to be this clean? Unfortunately not; but these potential entries do offer us an opportunity to initiate a position during a strong trend; and only if we get the direction movement that we want.

One of the primary allures for traders utilizing breakout strategies is the potential money management scenarios; and given the recently published research from DailyFX regarding FX Client profitability (The Traits of Successful Traders Series), advantageous money management situations can be extremely beneficial for traders.

When trading breakouts, it’s important to remember the thesis statement from the Number One Mistake Forex Traders Make:

Traders are right more than 50% of the time, but lose more money on losing trades than they win on winning trades. Traders should use stops and limits to enforce a risk/reward ratio of 1:1 or higher.

The Inside Bar is a potential mannerism that traders can look to trigger into trades to employ risk/reward ratios of 1:1 or higher.

--- Written by James B. Stanley

To contact James Stanley, please email Instructor@DailyFX.Com. You can follow James on Twitter @JStanleyFX.

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DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.