You may have come across an inside bar trading strategy or even currently trading one.
But do you know what an inside bar is? Inside bar refers to a double candlestick pattern in which the range of the second candlestick lies within that of the first candlestick.
Strictly speaking, the inside bar is a term for describing that particular pattern in a bar chart and is not a Japanese candlestick terminology.
The Japanese term for that very pattern is the harami or the harami cross — if the second candlestick is a doji.
It appears that the use of inside bar to describe that candlestick pattern is an attempt to merge bar chart patterns and the Japanese candlestick patterns by using bar chart terminologies for the corresponding candlestick patterns.
Whatever the case, you are about to learn the inside bar trading strategy that works. But, before then, let’s explain the anatomy of an inside bar and the psychology behind it.
Inside bar candlestick pattern anatomy
In the candlestick context, the inside bar pattern is a 2-candlestick pattern whereby the range (both body and wicks) of the second candlestick (called the inside bar) lies within the range of the first candlestick (called the mother bar).
Each of the two candlesticks that make up an inside bar pattern can have any shape, provided the second one lies within the first one.
So, you can have other candlestick patterns, such as pin bars, dojis, and others, form an inside bar pattern.
The two candlesticks can have any color combinations — bullish/bearish, bearish/bullish, bullish/bullish, or bearish/bearish — but the color combination doesn’t necessarily determine the significance of the pattern.
What determines whether the pattern has a bullish or bearish implication is the position of the pattern in the entire price action.
Inside bar with bullish significance
An inside bar is considered to have a bullish implication if it occurs at the end of a price decline — a pullback in an uptrend or a swing down in a ranging market.
Both candlesticks in the pattern can have any color, but a bearish/bullish or bearish/doji combination is logically more in tune with what the pattern stands for — an accumulation and a potential bullish reversal.
Inside bar with bearish significance
The inside bar pattern is considered to have a bearish significance if it occurs at the end of a price swing up — a pullback in a downtrend or an upswing in a ranging market.
While both candlesticks in this situation can have any color, a bullish/bearish combination or bullish/doji combination is considered more in keeping with what the pattern indicates — a bearish accumulation and potential downward reversal.
The psychology behind inside bars formation
An inside bar pattern indicates that the market is in a period of consolidation or indecision.
It could mean that there is reduced activity in the market or that some major market players are accumulating a position.
Whatever the case, there’s a need to analyze it with the volume data to get a better picture of the activity in the market.
When the candlestick pattern occurs following a price decline, it could mean that the decline has run its course — with a possible capitulation (tall bearish mother bar) — and the institutional players are quietly accumulating their long positions.
In this case, expect the price to break out of the pattern and climb up. This is most likely if the second candlestick (inside bar) forms on high volume.
The pattern could also mean that the market paused to consolidate before continuing to decline.
In some cases, this decline fails after breaking below the patterns low, and the price turns upwards, giving rise to a bullish hikkake pattern.
If an inside bar occurs after a rally, it could be that the buying frenzy has climaxed (tall bullish mother bar), and the big boys are silently accumulating short positions, after which they will push the price down.
It could also mean that the rally is taking a breather and would break out of the pattern to continue climbing. Some other times, the breakout fails, and the price reverses, creating a bearish hikkake pattern.
Trading inside bars with the trend
There are different inside bar trading strategies you can learn, but as a beginner, it’s better to start with price action signals that occur in the direction of the trend.
This way, you keep yourself from randomly trading any inside bar patterns you see on your chart, which can lead to lots of failed trades.
Trading in the direction of the trend helps increase the chances of a favorable outcome.
But you also need to look for some other factors that support the candlestick setup. Some of the tools you can use to identify high probability inside bar setups include :
- Support and resistance levels
- Fibonacci retracement levels
- Moving averages
- Trend lines
Support and resistance levels
When the market is trending, it moves in a series of impulse (trend direction) and corrective (pullback) waves, which create multiple support and resistance levels in the market.
A support level is a level below the current price where the price can potentially reverse to the upside, while a resistance level is somewhere above the current price where the price can potentially reverse to the downside.
For a market in an uptrend, impulse waves move upwards and tend to reverse at known or new resistance levels, while the pullback waves go down and reverse at support levels.
When the price climbs above a known resistance level, that level, which is now below the price, becomes a support level.
So, in an uptrend, look for the inside bar pattern at the end of a pullback at a known support level so that you can ride the impulse wave in the direction of the trend. This way, you are making high probability trades.
Looking for this price action signal around a resistance level and trying to trade against the trend direction could be disastrous.
In the AUD USD chart below, the price is trending up and broke the resistance level, which later became a support level.
The next pullback ended there with the formation of an inside bar, and the price started climbing again.
In a downtrend, look for the inside bar pattern at the end of a rally to a known resistance level so that you can ride the impulse wave down when the price resumes the decline.
In the AUD USD chart below, the price is in a downtrend. It broke below a support level, which turned to a resistance level. When the price pulled back to the resistance level, it formed an inside bar pattern twice and dropped again.
Fibonacci retracement levels
With the Fibonacci retracement tool, you can improve how you trade Japanese candlestick setups.
The tool helps you to predict the levels in the market that can potentially act as a support or resistance level.
Derived from the ratios of the Fibonacci sequence, the retracement levels estimate the percentage of the preceding impulse that the pullback can get to before reversing.
When a pullback starts, attach the Fibonacci retracement tool to your chart, from the low to the high of the preceding impulse wave, and then, look out for inside bar signals when the pullback reaches the 38.2%, 50%, and 61.8% levels, which are usually the most significant levels.
The patterns that occur at these levels are likely to reverse the price to the trend direction.
In the AUD USD chart below, you can see that the inside bar pattern occurred when the pullback got around the 61.8% Fibonacci level, which acted as a support level. Afterward, the price reversed to the trend direction.
The GBPUSD chart below shows a downtrend, with the Fibonacci levels acting as resistance levels.
Notice that an inside bar pattern formed around the 61.8% retracement level, and the price dropped afterward.
Moving averages
When trading the Japanese candlestick patterns, the moving average indicator can be quite useful.
Not only does it help you to identify the direction of the trend but can also provide some support or resistance functions.
You can choose any type of moving average you want — simple, exponential, or linear-weighted — and use any period you like, but here, we are using the 8-period or 21-period simple moving average at the session close.
In an uptrend, the moving average indicator, especially the longer-period moving average, can act as a dynamic support level.
If you want to use the moving average indicator to support your inside bar trading strategy, it’s important you wait for the price to pull back to the indicator line and look for the price action signal there.
In the AUD JPY H1 chart below, the market is trending up and frequently making pullbacks to the 21-period moving average.
As you can see, one of the pullbacks to the moving average indicator ended with an inside bar, and the price subsequently started climbing again.
In a downtrend, the moving average indicator, especially the longer-period moving average, can act as a dynamic resistance level.
As you can see in the chart below, the price was in a downtrend and made some pullbacks to the moving average indicator.
Notice the inside bar pattern that formed at the end of one of the pullbacks to the indicator and how the price later started declining again.
Trend lines
When trading candlestick patterns with the trend, trend lines can be very useful. Trend lines help you to identify the direction of the trend, but they also act as dynamic support or resistance lines.
When the market is trending up, you apply the trend lines at the lows of the series of pullbacks.
So, the trend lines will act as potential support levels for future pullbacks. See the GBP CHF chart below.
The price is in an uptrend and the pullbacks tend to end around the trend line. Notice the two occasions where an inside bar formed at the end of the pullback and how the price traded upwards.
On the other hand, when the market is in a downtrend, you apply the trend lines across the highs of previous rallies so they act as future resistance levels.
In the GBPUSD chart below, the market is in a downtrend. One of the rallies to the trend line ended with an inside bar.
Inside bar order entry and exit strategies in a trending market
When trading an inside bar pattern with the trend, there are a few ways you can place your order:
- For a long position, a buy stop order a few pips above the high of the inside bar or mother bar candlestick, and for a short position, a sell stop order a few pips below the low of the inside bar or mother bar candlestick
- A market order at the close of the candlestick that closes above the pattern (when going long) or below the pattern (when going short)
For your stop loss order, place it below the preceding swing low if you are long. You can also use the low of the mother bar candlestick if it’s reasonable far from your entry, but it carries a higher risk of being stopped out before the impulse wave begins.
In the case of a short position, place your stop loss order above the high of the preceding swing or above the mother bar’s high — but this carries a higher risk of being stopped out.
You can estimate your profit target with any of these methods:
- Fibonacci extension or expansion levels
- The next support or resistance level
- The average size of impulse waves in the trend, measured from the low/high of the pullback you’re trading
- A risk/reward ratio of 2:1 or 3:1
Trading inside bars in ranging markets
Another inside bar trading strategy that works well is trading the pattern in a ranging market.
In a ranging market, the price moves sideways within the established boundaries, but after some time, it may break out of the range.
So, you must be ready to get out fast if a breakout happens, since the price can move very fast in such situations.
To trade a ranging market successfully, you will need to make use of these tools:
- Support and resistance zones
- Oscillator indicators
Support and resistance zones
To be sure that the market is actually in a range, you need to mark out the boundaries by connecting two consecutive swing highs as the upper boundary and two consecutive swing lows as the lower boundary.
The upper boundary is the resistance zone, while the lower boundary is the support zone.
When the price reaches any of the boundaries, look out for an inside bar pattern. The formation of the pattern around the range boundary shows that the move is exhausted and the price will likely reverse at any moment.
The USD CAD chart below shows a market that was in a range.Notice the first inside bar that appeared when the price slightly overshot the lower boundary in July and how the price turned upwards.
The upswing ended at the opposite end in October with another inside bar, and the price turned downwards, ending yet again with an inside bar formation.
Again,the price reversed to the upside and eventually broke out of the upper boundary.
Oscillators
Oscillator indicators are very helpful in trading a ranging market since they show when a price move is losing momentum and likely to reverse.
They can serve as further confirmation that the price wants to reverse. These indicators are fashioned in such a way that they move between overbought and oversold regions or oscillate about a midline, as the price moves up and down in a range.
Examples of price oscillators you can use to support your inside bar trading strategy in a ranging market include the stochastic, OsMA,CCI, William %R, the momentum indicator, the relatives strength index and even the MACD. A trade signal often involves any of the following:
- The indicator coming out from the overbought region (a sell signal) or the oversold region (a buy signal)
- The indicator bars (MACD, OsMA) rising from below the midline (buy signal) or descending from above the midline (sell signal)
- A divergence between the oscillator indicator and the price swing high or low
Here are the things you’ll notice in the EURGBP chart when you add a 14-period stochastic:
- When the first inside bar pattern formed at the lower boundary, the stochastic was in the oversold region, showing that buyers were ready to step in.
- The inside bar pattern that formed at the upper boundary coincided with a classical bearish divergence in the stochastic, showing that the bears were about to make a move
- The next inside bar pattern that formed at the lower boundary coincided with an oversold signal in the stochastic, again, indicating that the bulls were ready to move in.
Inside bar order entry and exit strategies in a ranging market
There are a few ways you can place your order when using an inside bar trading strategy in a ranging market:
- You can place a market order once the inside bar pattern has completed at the boundary, especially if an oscillator signal is confirming it.
- You can place a stop order a few pips above the pattern’s high (for a long position) or below the pattern’s low (for a short position)
- You can also wait and place a market order after the close of the candlestick that breaks out above or below the pattern, as the case may be
For a long position, place your stop loss a few pips below the mother bar’s low. If you are short, place your stop loss a few pips above the mother bar’s high.
The essence is to quickly get out when the price breaks out of the range. Your profit target should be a few pips before the opposite boundary.
Mistakes to avoid when trading inside bars
While this Japanese candlestick pattern can offer some trading opportunities, you can’t just trade it randomly and expect a good outcome.
There are many mistakes new traders make when using an inside bar trading strategy. Here are the common ones and how to avoid them:
Going against the main trend
Some inexperienced traders trade the pattern against the direction of the main trend thinking it can cause the trend to reverse.
This can be very disastrous as the pattern can be a consolidation for a resurgent price continuation if it’s occurring in the impulse wave.
The best way to trade the inside bar pattern in a trending market is to use it as a potential pullback reversal signal so that you can ride the next impulse wave.
This way, you increase the odds of a successful outcome.
Trading inside bars on their own
Naïve traders tend to trade the inside bar patterns on their own, which is the wrong way to do it. Even when trading this price action signal in the direction of the trend, it’s not advisable to trade it as a stand-alone signal.
You need to look for other confluence factors that support the trade so as to increase the chances of a good outcome.
Tools like support and resistance level, Fibonacci levels, trend lines, and moving averages can be very useful.
You will want to see many of these factors supporting an inside bar pattern before you place your trade.
In addition, it is preferable to analyze the pattern with the volume data.
Ignoring other price action
Some people may only focus on identifying the pattern and making their trades, without trying to understand what the surrounding candlesticks are saying.
If you want to master your game, you need to learn how to read the entire price action to understand the broad market context.
This way, you don’t need to memorize the individual candlestick patterns.
Putting stop loss too close to your trade entry
If you haven’t heard it before, hear it now — placing your stop loss close to your entry is quite dangerous.
You may think you are risking fewer pips by doing that, but you are losing more money. What’s the point of trying to risk fewer pips if you repeatedly get stopped out at the very beginning in a trade that should have been a winner? It’s simply not worth it.
Final words
If you understand the inside bar trading strategy and always do the right thing, you can make a consistent profit with it.
Trade in the direction of the trend, with the help of other confluence factors, such as support and resistance levels, Fibonacci retracement levels, moving averages, and trend lines.
You may also trade it in a ranging market. But always make sure you use a reasonable stop loss.