24 Dec

The Inside Bar – Price Action Trading Strategy  

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Are you a fan of no-frills chart analysis?

I know plenty of traders who are.

The elegance of a simple, pure, and clean stock chart— can make them look like witchdoctors to the untrained eye…  

…it looks like reading tea leaves and dark voodoo magic when  I watch a trader navigate the markets without using indicators.

The strategy I am going to teach you will change the way you look at stock charting—FOREVER.

It will declutter the mess of indicators and make you focus on what really matters… price action!

It’s called an Inside Bar, and it is a simple but extremely powerful candlestick pattern.

Why is it so powerful?

Well, it can help you time your entries better with extremely low risk!

Want to know one of the best parts about it?

This pattern can be used as a trend following entry or a market reversal signal.

But first…

Price Action – The Inside Bar

An Inside Bar is a candle that is completely covered by the prior candle.  

Here’s what that means…

What does this mean?

This means there is reduced volatility in the markets.  However, not all Inside Bars are created equal.

Inside Bar with a small range

This is like the image above that the current bar is covered by the prior bar.  The major difference is that the current bar is much smaller.  

What is the importance of this bar?

It tells traders that there is a lot of indecision and lower volatility in the markets.

An example:

Large Lange Inside Bar (LR Inside Bar)

The next type of Inside Bar you have is a Large Range Inside Bar.

This still falls into the category of an Inside Bar since the candle is being covered by the bar before it.

Except there is one main difference.  And that is the range of the current bar.

Depending on the market conditions, this could represent continued strength in an uptrend or a reversal in a downtrend.

Let’s take a look at a LR Inside Bar:

Here is an example of an LR Inside Bar with weaker price action.

Notice how the wicks are very long and the body is short and red.  

This price action indicates that the bulls were in control and failed to maintain the stock near its high price.  The bulls ultimately surrendered to the bears and therefore the weaker price action was seen.

Multiple Inside Bars

What happens when many bars form an inside bar?

This creates a pattern that resembles a triangle and signals to traders that an explosion of volatility is about to come.  

As you know…volatility is always changing in the markets.

This is why it’s very important to be able to identify and predict when these shifts in volatility are going to occur.

Here is what I mean:

Inside Bar Trading Strategy

There are many ways to trade the Inside Bar with strategies for any market condition.

Here are the two trades that you should look out for.

  1. Reversals
  2. Trend Following

Let’s take a look at each and the strategy that can be used to capitalize on an Inside Bar pattern.

Now…

Inside Bar – Reversals using Support and Resistance

Many traders love to trade Support and Resistance lines in the markets since they give some of the best risk-to-reward ratios available.

For example,

The price of the stock is approaching a resistance level and then forms an Inside Bar.

Instead of immediately trading the breakout, wait for the market to make a reversal move first and then trade the Inside Bar.

There are two reasons for doing this:

  1. The buyers are officially in control
  2. There is volatility contraction after the reversal and the buying or selling pressure should continue if price breaks out.

Let’s take a look at an example of this setup in the SPY.

In the chart above, you can see the markets reversed at the Area of Support and had a period of increased volatility before heading higher.

The trade?  

Now that price formed the inside bar after making a push higher it’s safe to enter the long position.

Next…Let’s take a look at a Trend Following Inside Bar example.

 

Inside Bar – Trend Following

So now you can successfully catch reversals in the markets using Inside Bars for confirmation.  

But what happens if you are too late to the party and the reversal and confirmation have already occured?

That’s where this next trading strategy comes into action.

Let’s take a look at how to use Inside Bars to follow the trend of the markets.

Here’s how it works…

In a strong trending market, only shallow pullbacks are typically seen (if any at all)!

So, how do we enter this trade the right way to keep from chasing the price?

Use an Inside Bar!

The Trade:

When the price “stalls” which is the formation of the Inside Bar, you want to enter as soon as possible as the price has a high percent chance of resuming in the direction of the trend.

Here’s how you do it:

  1. If the market is in a strong trend (price over 20 EMA), wait for a pullback to occur
  2. When a pullback occurs, wait for an inside bar to form
  3. Once the inside bar is formed, go long the break of the highs of the inside bar

Let’s take a look at a Long and Short trade on the SPY…

Long SPY:

  1. Price above 20 EMA
  2. Pullback towards 20 EMA
  3. Inside Bar formed

Let’s see the chart on the trade with the setup for the SPY’s.

In the chart above you can see that price traded above the 20 EMA indicating a strong upward trend in the market.

Shortly afterward, a pullback towards the 20 EMA along with an Inside Bar was spotted.

The setup was completed, and the entry would be at the open of the next bar.

Short SPY:

  1. Price below 20 EMA
  2. Pullback towards 20 EMA
  3. Inside Bar formed

Let’s see the chart on the trade with the setup for the SPY’s.

In the chart above you can see that price traded below the 20 EMA indicating a strong downward trend in the market.

Shortly afterward, a pullback towards the 20 EMA along with an Inside Bar was spotted.

The setup was completed, and the entry would be at the open of the next bar.

Inside Bar Breakout – Price Action Analysis

It’s important to remember that not all Inside Bars are created the same.  

There are some inside bars that have a larger range and others with a smaller range.

If a trader is looking to trade the breakout of an Inside Bar, the small range bars are the go-to setup.

Why?

Tighter Stop Loss

Breakout traders are looking for sudden and quick moves in their direction.  


Due to this quick profit requirement, these traders cannot take a lot of loss on their trades.

This means that traders are required to take as many trades as possible with as few stop losses as possible.

The benefit of trading a smaller range bar for a breakout is that a trader can put on a much larger position size and keep all risk consistent.  This will be required to maximize the profit potential on the trade.

Inside Bar – Stop Loss

When trading an Inside Bar, you don’t want to “set it and forget it” attitude.

Why?

Because there could be a false breakout causing poorly placed stops to be triggered or a complete failure of the pattern.

One way to set a stop loss is to instead place the order at 1 ATR away from the 20 EMA since the market tends to find support at the EMA level.


Why?  

This will protect your trade against a “fake out” move by the markets and keep you in your position for the correct move.

Another level to place your stop loss is below the larger candles highs or lows.  But don’t go too close!

This means placing your stop loss just below the lows of the Inside Bar is not a good way to trade this system.  Stops are easily triggered as the markets are trying to find a direction when placed here.

Instead, opt for placing them 1 ATR value over the highs or under the lows of the larger candlestick for enough wiggle room.

Price Moves Quickly

The stock market moves from periods of low to high volatility, back and forth as it makes it way higher and lower.

The thing is if a trader focuses on inside bars they are interested in capturing the shift between low and high volatility.  

And since volatility is going to expand quickly with the price movement, it’s highly likely that the trade will go in your favor quickly as well.  

This is a perfect opportunity for allowing a trader to have a higher risk-to-reward in a short amount of time.  

Wrapping Up

Remember traders…

  • An inside bar with small range signals low volatility and indecision in the marketplace
  • Not all Inside Bars are created equal.  
  • Make sure to protect trades by using an ATR as a measurement for stop loss

So no matter which pattern fits your trading style the best, it’s always great to have another trading system in your toolbox.

What I like about this strategy is how it fits multiple trading styles flawlessly and allows a trader to get into the markets at some of the most optimal levels.

Now get out there and trade those Inside Bars!

P.S.  Let me know in the comments below how this pattern worked for you!

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