The Inside bar breakout strategy is a powerful price action strategy. Its distinction is the simplicity of application and good rewards it offers compared to the risk. Also it allows us to get into trending moves. So, it is considered one of the greatest strategies applied in Forex trading.
Structure of Inside Bar
An inside bar is actually a single bar (or candle) that is completely inside the preceding bar. For clarity, the entire price action of the inside bar (body and wicks) are covered and contained within the range of the previous bar. In the following illustration, we can see that the high of the bar B (inside bar) is lower than the high of the bar A (mother bar), and the low of the bar B is higher than the low of the bar A.
Illustration 1: structure of inside bar
Inside Bar Psychology
An important effect of any technical pattern is derived from its psychological meaning. When we want to detect the inside bar psychology, we will figure out that it represents a time of indecision or consolidation in the market, where neither the bulls nor the bears are in charge. The bears can’t make a lower low, and the bulls can’t make a higher high. Consequently, the inside bar formation occurs under the following circumstances:
- Price consolidation after a large up/down move before starting another round of movement in the dominant trend direction.
- Price facing a strong key level (support or resistance) which makes some hesitation in the market as to whether it will break the key level and continue or not and reversed.
- Ranging markets due to the lack of liquidity and the reduction of traders’ participation. Hence, we can consider the inside bar as a trend continuation signal and a reversal signal alike.
Illustration 2: Here we can see many inside bars which act as a continuation signal in-line with the dominant trend direction. And this offers us a great opportunity to be in the next leg of the movement after price consolidation.
Illustration 3: Here we can see an inside bar at a key support level that acts as a reversal signal, also an inside bar with a big mother bar, and an inside bar in the ranging market that we must ignore.
Trading the Inside Bar
It is important to realize that we cannot trade every inside bar profitably, so we must detect the reliable and accurate inside bars. In fact, the best setup for such a strategy is to trade only in the direction of the trend as a continuation signal, and trade only on a daily time frame. We must ignore the inside bars formed during the ranging markets and low liquidity.
Since we trade inside bar as a continuation signal, we can take trades as follows:
Entry: we enter an inside bar on a breakout of the mother bar high or low. If the trend is up, we will place a buy stop entry order just above the mother bar high, and if the trend is down, we will place a sell stop entry order just below the mother bar low.
Stop loss: we place a stop loss order just above or below the mother bar high or low. If the trend is up, we will place stop loss order just below the mother bar low, and if the trend is down, we will place stop loss order just above the mother bar high.
If we trade inside bars with larger mother bars, we will place our stop loss near the mother bar 50% level (the midpoint) between the high and low of the mother bar. The tremendous advantage of this strategy is that it offers a small stop loss. Thus, it ensures a reasonable risk reward ratio for the trader.
An example below is related to the USD/CAD Daily chart. We can see the trend which is clearly to the upside, this means that the bulls are in charge. And there are two inside bars which are in-line with the uptrend, resulted in the breakout continuation move. The price climbs up for about 250 pips.
Illustration 4: an example of inside bar on the USDCAD daily chart
The great thing about the inside bar strategy is that it gives us a good chance to get into trending moves. When we see an inside bar on our charts, it means that the traders are unwilling to move the price higher or lower. This situation is usually followed by the increased volatility, which offers us a good opportunity.
The article is written by Israa Shehata and is participating in the Forex Article Contest. Good luck!