The Inside Bar Strategy

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The Inside Bar Strategy is a strategy based on one of popular candle formations, which indicates about uncertainty on the market. Descriptions of the Inside Bar pattern occurs in articles about Japanese Candlestick Patterns (old Japanese technique of technical analyses, translated and described by Steve Nison in the early 90s) .

Strategy

The strategy uses Inside Bar formation as the entry point in the market. Must be remembered that Inside Bar formation occurs during a firm trending periods and indicates about uncertainty or low interest of traders in the current market situation.  Therefore, using additional rules after formation of the Inside Bar it is possible to catch significant movements, whether it is a continuation of the trend or it is a reversal.

Inside Bar

The Inside Bar formation requires only two bars to appear. It can appear during both Uptrend and Downtrend movements. The pattern should arise during relatively large movements, not in the quiet periods.

To identify Inside Bar pattern one need to follow next steps:

  • Identify current trend. It should be solid trend movement, preferably with fundamental background;
  • The first bar should have the same direction of the trend;
  • The body of the second bar must be smaller than the body of its predecessor. Direction of the bar does not matter;
  • Current bar considered as inside candle if it is completely covered by the price action of previous candle bar;

If current bar (or second bar of the formation) has index (i) and the previous bar (or first bar of the formation) goes with index (i-1) then the rules will be:

  • High(i-1) > High(i)
  • Low(i-1) < Low(i)
  • ABS(Close(i-1) – Open(i-1)) > ABS(Close(i) – Open(i))

Inside Bar on the uptrend

Setup

This strategy useful only for higher timeframes. Notably, Japanese Candles Analyses were used for Monthly or Weekly candles. The reason for this was the absence of the lower timeframes. Nonetheless, it is not recommended to use this strategy on timeframes lower than 4 Hour bars. Rules:

  • Any trading instrument is suitable
  • To avoid the impact of market noise we recommend to use time frames higher than 4 Hour;
  • Open Candles Chart

Entry rules

The Inside Bar pattern itself shows that traders are in abeyance and do not know to move market further or to wait for the rebound. Generally speaking, prediction of the market behavior after the formation depends on the next bar.

There are four possible scenarios:

  • Inside Bar appears during downtrend
    • Trend changes direction
    • After Inside Bar formation trend continuous
  • Inside Bar appears during uptrend
    • Trend changes direction
    • After Inside Bar formation trend continuous

Inside Bar changing trend

Condition on how to trader determines whether the trend continues or changing after Inside Bar is the trigger for the trade. Notably, there are couple possible variations of such conditions; this strategy uses middle-risk condition.

The first step of determining a trading signal is to identify current trend.

Buy signal:

  • Market is in Uptrend and Inside Bar appeared
    • Next bar current price crosses High of the Inside Bar candle from the bottom up
  • Market is in Downtrend and inside Bar appeared
    • Next bar current price crosses High of the Inside Bar candle from the bottom up

Sell signal:

  • Market is in Uptrend and Inside Bar appeared
    • Current price crosses Low of the Inside Bar candle from above-down
  • Market is in Downtrend and inside Bar appeared
    • Next bar current price crosses Low price of the Inside Bar candle from above-down

Sell signal during uptrend

inside bar sell trade on the uptrend

The condition of entry – intersection of the Low of the second bar of the Inside Bar formation.

Exit rules

The strategy allows several exit rules: Stop Loss, Take Profit and Early Exit rules.

Stop Loss

There are several rules to evaluate Stop Loss, which underlay different risk levels. Usually, Stop-Loss set to the support levels and pivot points. Rules for the Buy signal, for the Sell signal rules should be vice versa.

  • High or Low of the first bar of the Inside Bar formation (High for Sell, Low for Buy)
  • Recent Support/Resistance level
  • Current Price – k* ATR (Average True Range show average price motion; k between 2 and 5)

Take Profit

Take Profit is the desired level of profit and must correlate with Stop Loss level. Therefore, one of the most important indexes of the strategy is relation SL/TP. This relation is called risk/reward level of the strategy.  (rules are for the Buy signal):

  • Local peak of the price (in a range of a trading week)
  • Closest upper Pivot Point
  • Maximum of the first bar of the Inside Bar formation
  • Current price + k*Standard Deviation (Standard Deviation indicator stands for an average price motion; k between 0.5 and 1)
  • Current price + k*ATR (ATR – average true range, calculated on a different principal than Standard Deviation; k between 0.5 and 2)

Early exit rules

Early exit rules for Inside Bar strategy is simple –  exit the trade when the strategy gives the reverse signal, while the trade is still opened.

Sell signal during downtrend

inside bar sell trade on the downtrend

H4 EURUSD chart; Stop-Loss set to the High of the first bar of the formation. Take Profit set on level 1,3333; This signal gave 95 pips of profit.

Pros

Simple strategy. Good risk/reward coefficient.

Cons

The strategy works only on trending periods; Suitable only for higher timeframes.

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