In the fast-paced world of forex trading, having a reliable and effective price action trading strategy is one of the main keys to success. A strategy that Japanese candlestick chart traders often use is looking for and trading the inside bar pattern. This two-candle pattern can provide valuable trading opportunities when understood and used correctly.
In this article, Benzinga will explain and explore the inside bar pattern, including how to identify it on a candlestick chart, its essential characteristics and practical tips for trading it in the forex market.
What is the Inside Bar Pattern in Forex?
The inside bar pattern is a two-candle candlestick pattern that occurs on charts when the current candle's high and low exchange rates are contained within the range of the previous candle. The pattern is neither bullish nor bearish, but it is instead neutral in its implications until a breakout occurs which then tends to result in a considerable follow-on move.
The visual representation of this two-candle pattern resembles a smaller candle inside a larger candle. Check out the diagram below for an example of what an inside bar pattern looks like.
Diagram showing Inside bar patterns appearing after bearish red and bullish green candles. Source: Mysar-Academy.
Note that a smaller green inside candle can follow a bearish red mother candle or a smaller red inside candle can follow a bullish green mother candle. Also, the taller initial candle is often known as the mother bar, while the shorter second candle is typically called the inside bar in this candlestick chart pattern.
This candlestick chart pattern represents a temporary consolidation or pause in the forex market that suggests indecision prevails over the future direction of the market. This situation can in turn indicate a potential continuation or reversal of the prevailing trend once a breakout occurs.
By learning to recognize this important candlestick pattern when it occurs on exchange rate charts, currency traders can better anticipate future exchange rate movements and make more profitable trading decisions.
Identifying Inside Bar Patterns on a Chart
To identify inside bar patterns on a currency pair’s exchange rate chart, forex traders skilled in technical analysis typically look for candles whose high and low are fully encompassed by the previous candle's range. This sort of bar setup means that the high of the current candle is lower than the high of the previous candle, and the low of the current candle is higher than the low of the previous candle.
Trend
One important characteristic of the inside bar pattern is its relationship to the prevailing trend. Inside bars that occur within an established trend often indicate a continuation of the trend. In contrast, inside bars that show up at the end of a trend can signal a potential reversal. Forex traders should pay close attention to the context in which the inside bar pattern forms to determine its significance and to get a better sense of its possible breakout direction.
Timeframe
The timeframe in which the inside bar pattern appears plays an important role in its interpretation. Inside bars seen on candlestick charts with higher timeframes, such as daily or weekly exchange rate charts, tend to carry more weight and can lead to a stronger exchange rate or price movement once a breakout occurs. Even in shorter timeframes, however, inside bars can still provide valuable forex trading opportunities if the market context aligns with other supportive factors.
Breakout
One of the primary strategies for trading the inside bar pattern involves waiting for a breakout. After an inside bar forms, forex traders can set pending orders above the high or below the low of the pattern since they anticipate a breakout in the direction of the subsequent breakout candle. Once it occurs, this breakout confirms the resumption of the trending market or the potential reversal in the opposite direction.
Risk-to-Reward Ratio
When trading the inside bar pattern, it is essential to consider the risk-to-reward ratio of your trade. Remember to set your stop-loss orders below the low or above the high of the inside bar, depending on the eventual direction of the subsequent breakout. By determining your risk and potential reward before entering a trade and using the ratio of those factors as a trade decision criterion, you can better ensure that your trades have a favorable risk-to-reward ratio.
Size of Candles
The size of the inside bar candles can also provide valuable insights to a forex trader. In general, smaller inside bars indicate a period of tighter consolidation, which in turn suggests an imminent breakout. On the other hand, larger inside bars tend to represent a more significant pause in the market and can lead to more substantial exchange rate movements once a breakout occurs. Analyzing the size of the two candles that form the inside bar pattern can also help currency traders better gauge the strength of potential breakouts.
How to Trade Forex Using the Inside Bar Pattern
To trade forex using the inside bar pattern, you can follow these steps:
- Identify the inside bar pattern on your exchange rate chart.
- Determine the prevailing trend and the context in which the two-candle pattern forms.
- Assess the risk-to-reward ratio of the trade to ensure a favorable trade setup.
- If the risk-reward of the trade setup looks good, set your trade entry orders to buy above the high or to sell below the low of the inside bar in anticipation of a breakout.
- When one of your two orders is executed, make sure to cancel the other order.
- Once you enter into a position, remember to place your stop-loss buy order on a short position above the high of the inside bar or put your stop-loss sell order on a long position below the low of the inside bar.
- Monitor the forex market and manage the trade according to your inside bar pattern trading plan. You will want to have a clear profit-taking target in mind and can also consider protecting any profits that do accrue with a trailing stop order.
Tips When Trading Inside Bar Patterns
If you find the inside bar pattern intriguing and would like to include it in your trading strategy, then you might also benefit from a few tips about how to trade this candlestick chart pattern.
First of all, consider the prevailing trend and the overall market context before taking a forex trade based on an inside bar pattern. You will also want to use multiple timeframes to confirm the validity of the inside bar pattern.
Another tip is to set your stop-loss orders in the market as described in the previous section to help protect your trading capital from adverse exchange rate movements. You will also generally want to aim for a favorable risk-to-reward ratio of at least 1:2.
Finally, remember to use appropriate risk and money management techniques. For example, you should avoid risking more than a predetermined affordable percentage of your trading capital, and you should size your trading positions in a way that makes sense given your risk tolerance and account balance.
Benefits of Using the Inside Bar Pattern to Trade Forex
The inside bar pattern can be a valuable tool in a forex trader's arsenal. By understanding this pattern’s characteristics and using an effective trading strategy to take advantage of it, currency traders can identify high-probability trading opportunities.
Like just about any forex trading strategy, however, using the inside bar pattern requires practice and careful risk and money management to achieve the best results. By incorporating the inside bar pattern into your trading approach and following the tips outlined earlier in this article, you can enhance your trading skills and potentially increase your profitability when operating in the forex market.
Frequently Asked Questions
Is an inside bar bullish or bearish?
The inside bar pattern itself does not indicate a bullish or bearish bias since it instead only represents a period of consolidation. The subsequent breakout direction determines the bullish or bearish nature of this two-candle candlestick pattern.
What is the win rate for the inside bar strategy?
The win rate for the inside bar strategy can vary depending on various factors such as market conditions and trade management, but it is generally considered to have a favorable win rate when traded in alignment with the prevailing trend and using appropriate risk and money management methods.
Why is the inside bar important?
The inside bar pattern is important because it provides forex traders with valuable information about currency market consolidation phases and potential breakout opportunities. It can also help forex traders identify possible trade entry and exit points so they can make more objective trading decisions.
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About Jay and Julie Hawk
Jay and Julie Hawk are the married co-founders of TheFXperts, a provider of financial writing services particularly renowned for its coverage of forex-related topics. With over 40 years of collective trading expertise and more than 15 years of collaborative writing experience, the Hawks specialize in crafting insightful financial content on trading strategies, market analysis and online trading for a broad audience. While their prolific writing career includes seven books and contributions to numerous financial websites and newswires, much of their recent work was published at Benzinga.