If you are a fan of pure price action Forex trading using candlestick patterns, then this lesson will be of particular interest to you. Today we will discuss a powerful candlestick formation which can often precede a sharp price move.
This formation that I am referring to is the Inside Bar pattern. We will discuss the structure of the inside bar setup and the psychology behind it. And finally we will go through a few of inside bar variations that you should become familiar with.
The inside bar is a two bar candlestick pattern , which indicates price consolidation. In order to confirm this pattern you need to see a candle on the chart, which is fully contained within the previous bar. In this manner, the inside bar candle should have a higher low and a lower high than the previous candle on the chart.
Since the inside candle has a lower high and a higher low than the previous candlestick on the chart, this indicates that the currency pair is consolidating. Why is it consolidating? It is consolidating because the bulls cannot manage to create a higher high and at the same time the bears fail to create a lower low.
Since the Inside candle on the chart is a sign of a consolidating market, we can draw a horizontal support and resistance level around this range in anticipation of a future breakout. When the price exits the inside bar range, we expect that the price action will continue to move in the direction of the inside bar breakout. So as an informed price action trader, you should be looking for the break of the inside bar, which would provide a tradeable opportunity in the direction of the break.
The inside bar formation can be traded in a myriad of ways. What is most important is that the inside bar trading setup must adhere to pre-defined rules that the trader sets up per his own trading plan. We will discuss some examples of how a trader can approach setting up a trade when they see this pattern on their chart.
When the price action completes an inside candle on the chart, you should mark the low and high of the Inside Bar consolidation range. These two levels are used to trigger of a potential trade. In simple terms, if the price action interrupts the range upwards, then you should go long. If the price action breaks the range downwards, then you should trade the short side. The usage of a stop loss order is recommended for any Forex trading strategy.
The inside bar trading system is no different. You should always put a stop loss when trading inside candles. In other words, if the inside range gets broken upwards, you can buy the Forex pair and place a stop loss order right below the lower candlewick of the inside candle.
The same is in force for bearish breakout of the inside range, but in the opposite direction. In this case you could sell the Forex pair and you put a stop loss right above the upper candlewick of the inside bar. Projecting the potential move with Inside Bar Breakouts can be challenging. Often Inside Bar trades can lead to a prolonged impulse move after the breakout, so employing a trailing stop after price has moved in your favor is a smart trade management strategy.
Along with this, I typically like to use a fixed Take Profit target at 1. In this manner, if the stop loss is 80 pips from the entry, then the minimum target would be located at pips distance. The blue circle on the price graph above shows an inside bar candlestick pattern. See that the highest and the lowest points of the small bullish candle are fully contained within the previous bearish candle. This confirms the inside bar pattern on the chart.
The black horizontal lines on the image define the inside bar range — the high and the low of the pattern. When you spot a breakout through one of these two levels, then that would give you a signal in the direction of the breakout. In our case the price action breaks the inside range in bullish direction.
Aggressive breakout traders would consider buying when the price reaches a few pips above the inside candle high. In either case, your stop should be located below the bottom of the range as shown on the image.
As you see, the price accounts for a strong run up after the inside bar pattern breaks to the upside. One of the highest probability time frames to incorporate the Inside Bar Pattern is on the Daily Chart. When an Inside Bar Pattern appears on the daily timeframe , this is often referred to as an Inside Day pattern.
When you see an inside day pattern on the chart, this means that on a daily basis, the traders have failed to establish bullish or bearish control in relation to the previous trading day. In essence, the inside day candlestick has the same structure and attitude as the regular inside bar, but it is considered more reliable due to the fact that each candle encompasses a full day of trading activity. See the image below for a depiction of the Inside day pattern. The image shows an inside day trading setup.
The blue circle indicates the inside day pattern. The green arrow shows the successful breakout of the inside day formation. Note that we did have two prior attempts to break to the downside, which did not follow thru immediately. The initial breakout turned out to be a Pin Bar formation.
But the third attempt proved to be successful. But regardless, if we had followed our stop loss placement rules, then we were never in any danger of getting stopped out for a loss on this trade. To reiterate, the stop loss on this short trade should be located above the high point of the inside day as shown on the image above. As you see, after the bearish inside day breakout the price initiates a sharp decline, which could have been traded for a decent profit.
We will now shift our attention to another variation of the inside day trading pattern. This is the inside day coupled with the narrowest range of the last 4 days NR4. This pattern was originally popularized by Toby Crabel in his book entitled: Though this might seem a bit confusing at first, it is quite simple once you take a bit of time to understand it. This ID NR4 trading pattern is quite a prolific and reliable setup that astute traders can take advantage of.
The power of this formation is hidden in the consolidative character of the formation. Since the inside day candle is also the smallest of the last four daily sessions, this means that the range is relatively tight and it is likely to break out with a sharp reaction.
The trade entry characteristics of this pattern fully match with the typical inside bar methodology. The image demonstrates an inside day with narrow range a. The blue circle on the image points to the inside day candle. Also take note of the three blue arrows at the left side of the image, which shows that the previous three candles on the chart are actually bigger than the inside candle. Therefore, we confirm that the inside candle is also the narrowest range day of the last 4 daily sessions.
A conservative trader would identify the ID NR4 breakout when the price action closes a candle below the bottom of the pattern. An aggressive trader would identify the ID NR4 breakout when the price reaches a few pips below the bottom of the pattern. In each case, it would signal that the consolidative range is ending in favor of a downward price movement. A trader could prepare to enter a short position, and put in a stop loss above the high point of the pattern as shown on the image.
As you see, after the short signal, the price accounts for a strong decrease. The Hikkake pattern is another variation of the inside bar candlestick. However, it represents an Inside bar pattern failure. Patterns can and do fail, but many times these failed patterns can offer nice trading opportunities for those whose are quick to recognize the fakeout.
When you discover an inside bar breakout on the chart, you will most likely want to trade in the direction of the breakout.
However, the pattern could turn against you. The price action might reverse direction and quite possibly could break the range of the pattern from the opposite side. This will trigger your stop loss, because it should be located on that side of the range. Therefore, you will be stopped out of the position with a small loss. However, if this happens you should look to see if there is an Inside bar failure pattern emerging. In this next section we will take a closer look at the Hikkake pattern, which is an inside bar fakeout.
When you see this pattern, you should position yourself in the market to trade in the opposite direction to the one which you had previously placed. The Hikkake pattern is confirmed when there is an Inside Bar pattern, a breakout of the inside bar on the next candle, and then a reversal occurs, and breaks thru the opposite end of the Inside Bar. It is important that the breakout thru the opposite side occur within bars of the original breakout.
For example, If the inside bar breakout is bullish, you will typically want to buy the Forex pair. However, if price turns against you and it breaks the lower level of the inside range within the next bars, and triggering your stop loss, then you would want to consider reversing your position and going short. I like to put a stop loss above the highest point of the inside bar and set a 2: The image illustrates an inside bar on the graph, followed by a Hikkake pattern.
During the initial decline, the price action creates an inside bar candle formation on the chart. Thus we can mark the high and the low level of the inside range. These are the two black lines on the chart. The next candle which comes after the inside bar breaks the upper level of the range. This gives us an initial long signal on the chart.
As you see, the price begins to reverse afterwards, and within the next two bars, the price decrease leads to a break of the lower level of the range. This confirms the Hikkake pattern on the chart, and with that, we should get ready to initiate a trade to the short side.
In the examples provided throughout article, you saw that the standard inside bar and its variations can provide very attractive price action setups. And any trader, regardless of their trading style, can take advantage of and incorporate these patterns into their trading methodology.
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