The inside bar pattern occurs regularly within the financial markets. Incorporating the inside bar strategy within 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 only requires two candles to present itself. This pattern is a direct play on short-term market sentiment looking to enter before the ‘big moves’ that may take place in the market. The inside bar shows a reluctance of prices to progress above/below the preceding candle high and low indicating market indecision.
How to identify an inside bar on forex charts
The following steps are used when identifying the inside bar pattern on forex charts:
- Identify a preceding trend using price action/technical indicators
- Locate inside bar pattern whereby the inside bar is engulfed fully by the preceding candle high and low
Trading with the inside bar candlestick pattern: Top Tips and Strategies
Some traders consider it a continuation pattern though a breakout in the opposite direction is possible too. After price has trended up (or down) for an extended period, the pause in price movement (represented by the inside bar) precedes a reversal of the trend. Therefore, the inside bar is looked at for a short-term trade (or swing trading) in the counter-trend direction with the goal of holding the trade for less than 10 bars.
However, there is another way to trade inside bars and this is rooted directly from what the candle pattern does NOT reveal. When traders see an inside bar pattern form, it is interpreted as the markets unwillingness to push price higher or lower. This can be for any number of reasons:
- An extremely pertinent report is being issued soon, or
- The market just made a stratospheric leap and traders are tepid about bidding price much higher or lower.
Whatever the reason, the motive is the same: seeking potential volatility in an effort to increase profitability. When there is a situation in which traders are unwilling to bid price higher or lower, it is seen as a potential situation for future increases in volatility. The inside bar candle pattern is NOT telling traders that the market is bidding price higher or lower but rather that the market is waiting before making the next big move in the asset. This means potential opportunities for traders.
1) Inside Bar breakout strategy
As mentioned previously, the inside bar represents a period of short-term consolidation with low volatility within a trending market. Traders then look to trade breakouts after a new high/low is formed.
In the EUR/GBP chart below, the preceding trend is seen by lower lows and lower highs. The breakout occurs below the low of the ‘preceding bar’ thus triggering a short entry into the market. Had this breakout occurred above the high of the ‘preceding bar’ then this can signal a long (buy) entry indicating a potential reversal in trend. Trading against the trend carries more risk which leads to greater caution taken by the trader.
Stop levels can be taken from the previous swing high/low (dependant on trend) as dictated by key price action levels. Using the stop as a benchmark, traders can use this stop distance to expand by a factor of two to realise the take profit (limit) level. This creates a 1:2 risk-reward ratio in line with responsible risk management. Fibonacci extensions may also be utilised as a limit forecast.
How reliable is the inside bar candle?
Inside bars signal continuation or reversals, which makes this trading pattern more complex. False breakouts can occur which lessens the reliability of the inside bar as an isolated pattern which is why traders prefer using the inside bar as part of an overall forex trading strategy. That is, the strategy is the foundation with the inside bar seen as more of a prompt.
| 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 |
Learn more about trading with candlestick patterns
- Further your knowledge on other forex trading patterns with the following:
1. Rising wedge
3. Double top
- Test your knowledge of forex patterns with our interactive 'Forex Trading Patterns' quiz.