The is a two bar 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 candle should have a higher low and a lower high than the previous candle on the chart.
The is fairly easy to spot on the chart, but using an indicator can assist the trader in quickly finding these patterns on their price chart as well.
Psychology behind the Inside Bar
Since the inside candle has a lower high and a higher low than the previous 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. As such, there is not sufficient buying or selling pressure to break the previous bar’s high or low.
Entering an Trade
When the price action completes an inside candle on the chart, you should mark the low and high of the consolidation range. These two levels are used to trigger of a potential trade. Remember, the inside candle clues us in to the eventual breakout and likelihood of a continuation outside the range in the direction the break, however, it doesn’t give us information about the direction of the breakout through the range, prior to the actual move.
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.
Stop Loss when Trading Inside Bars
The usage of a stop loss order is recommended for any Forex trading strategy. The trading system is no different. You should always put a stop loss when trading inside candles. But where?
The proper location of your stop loss is slightly beyond the inside candle’s top, or bottom, depending on the direction of the break. 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 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 .
Take Profit on Setup
Projecting the potential move with Breakouts can be challenging. Often 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 1.5:1 or 2:1 reward to risk ratio to scale out of inside bars trades. In this manner, if the stop loss is 80 pips from the entry, then the minimum target would be located at 120 pips distance.
Let’s take a closer look at the pattern on the Forex chart upside.