Inside Bars (And How to Trade Them)

This next formation can also help us find potential trading ideas; and its not because of what price is doing during the period of that candle, but its more about what price is NOT doing as the candle is forming.

The Inside Bar, is a popular candle formation that only requires two candles to present itself; as this is a direct 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 candles price action being completely covered from price action the day before. The chart below illustrates a textbook Inside Bar.

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 prices 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).

But there is another way to play inside bars; and this is rooted directly from what this candle is NOT telling us.

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 traders 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.

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

Its not telling us that traders are 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 we have situations in which we know volatility has decreased, particularly when these events (inside bars) take place in a prolonged-trending move; we can look to trade breakouts so that if (and when) a new high or low is established we look to get in the trade.

Traders utilizing this strategy are looking to trade Breakouts. which many traders in the FX Market look to in an effort to take advantage of the longer-term, stronger-trending moves in the market.

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.

Created with Marketscope/Trading Station

As you can see, 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.

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, its 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.

If youd like to see an actual inside bar that we had presented to our readers, my colleague Walker England had written an article on January 30 th. 2012 entitled GBP/USD, Inside Bar Spurs Breakout Entries .

In the article, Walker points out that the daily candle on 1/30 formed an inside bar. In the article, Walker goes on to further state:

Breakout traders can use entry orders to trade a break of either the previous high or low. Expectations are that price will break and continue forming either a new high or low past this point.

The chart below shows the exact candle that Walker was discussing/pointing out in the article; and we can see the way that this one plays out.

Created with Marketscope/Trading Station

— Written by James B. Stanley

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