Wondering what an inside bar pattern means in trading? Imagine you were looking at a chart of price movements. An inside bar pattern happens when one candle, or bar, is completely within the range of the previous candle. In simpler terms, the high and low points of this smaller, second candle fall within the range of the first, larger candle. This pattern could give traders clues about potential market trends. Keep reading to learn more about it.
What is the inside bar pattern in trading?
The inside bar pattern in trading is a two-bar setup on a price chart. It occurs when the second bar, called the "inside bar," is completely within the high and low range of the first bar, known as the "mother bar." This means the inside bar’s highest point is lower than the mother bar’s highest point, and its lowest point is higher than the mother bar’s lowest point. This pattern shows that the market is in a consolidation phase, meaning it's not moving much. Traders use this pattern to anticipate potential future market movements, either a breakout or a reversal.
Example of an inside bar
Imagine you wanted to trade Tesla stock, which is currently trading at $200. On your chart, you notice two consecutive candles. The first candle, known as the “mother bar,” has a high of $205 and a low of $195. The next candle, the “inside bar,” has a high of $202 and a low of $198.
In this example, the inside bar’s high and low are entirely within the range of the mother bar. Specifically, the high of the inside bar ($202) is lower than the high of the mother bar ($205), and the low of the inside bar ($198) is higher than the low of the mother bar ($195). This creates a smaller bar contained within the larger one.
This pattern indicates that the price of Tesla is consolidating, as it is trading within a narrower range compared to the previous bar. Traders might use this setup to anticipate a potential breakout or reversal. For instance, if the price breaks above the high of the mother bar ($205), it could signal a continuation of an upward trend. Conversely, if it breaks below the low of the mother bar ($195), it could indicate a potential downward move.
How to trade with inside bar pattern
How do you trade with the inside bar pattern? First, look for the inside bar setup on your chart. Once you spot it, decide whether you want to trade in the direction of the trend or against it.
For a trend-following trade (breakout), place a buy order slightly above the high of the mother bar if the trend is up, or a sell order just below the low of the mother bar if the trend is down. This way, you enter the trade when the price breaks out of the consolidation phase.
For a counter-trend trade (reversal), look for the inside bar at key support or resistance levels. Place a buy order above the high of the inside bar if you think the price will reverse upwards, or a sell order below the low of the inside bar if you expect a downward reversal.
Set your stop loss at the opposite end of the mother bar or halfway if the mother bar is large. This helps limit your losses if the trade doesn’t go as planned. Inside bars work best on daily charts and can sometimes have multiple inside bars within one mother bar, showing extended consolidation.
When is the inside bar pattern broken?
The inside bar pattern is broken when the price moves outside the range of the mother bar. For a bullish breakout, the pattern is broken when the price rises above the high of the mother bar. For a bearish breakout, it’s broken when the price falls below the low of the mother bar. This movement signals that the market is moving away from the consolidation phase and potentially starting a new trend. Essentially, the inside bar pattern is invalidated if the price breaks out in either direction, indicating that the market’s previous indecision is over.
Advantages and disadvantages of inside bar trading
| S/N | Advantages | Disadvantages |
|---|---|---|
| 1. | Clear signal: Inside bars provide a clear and easy-to-spot pattern indicating consolidation and potential market moves. | False signals: Inside bars can sometimes lead to false breakouts, where the price moves outside the pattern but then quickly reverses. |
| 2 | Risk management: Stop loss placement is straightforward, often set at the opposite end of the mother bar, allowing for clear risk management. | Limited by timeframe: Inside bars work best on higher timeframes like daily charts and may be less effective on lower timeframes due to increased noise. |
| 3. | Trend continuation or reversal: Offers opportunities for both trend-following (breakout) and counter-trend (reversal) trades. | Requires patience: Trading inside bars may require patience, as the pattern can take time to form and validate. |
| 4. | Tight stop loss: Often results in tight stop losses, which can improve risk-to-reward ratios. | Not always predictive: Inside bars may not always predict significant price moves, leading to potential missed opportunities. |
Experience Skilling's award-winning platform
Try out any of Skilling’s trading platforms on the device of your choice across web, android or iOS.
Conclusion
Traders find the inside bar pattern valuable for identifying potential market moves, whether for trend continuation or reversals. Its clear structure makes it easy to spot and trade, offering opportunities for both breakout and counter-trend strategies. However, while the pattern could signal consolidation and possible future direction, it may also produce false breakouts. Effective risk management is crucial to mitigate potential losses, typically by placing stop losses at strategic points like the opposite end of the mother bar. Source: priceaction.com
