Inside bars are a popular candle formation, that refer to a single bar or a series of bars that are completed contained in the price action of the previous bar also called the A bar. The basic feature of an inside bar is that its price action is completed covered by the price action of the A bar or prior bar.
In this picture, the red bar is the inside bar and its high and low are completely covered by the high and low of the previous blue bar.
Significance of Inside Bars
Inside bars can be viewed as with trend continuation patterns in strong trends, while potential reversal patterns at key levels. The inside bar signifies a pause in the price movement after a trend, whether up or down, has been witnessed for a long period of time. This is why it is taken as an indicator of a reversal of the trend at a key level, while a with trend setup in a strong trend..
Another set of traders and analysts try to analyze what the inside bar or the candle is not telling. Since the high and low of the inside bar are inside the high and the low of the day before, it may signify the unwillingness of traders to push the price either higher or lower. This situation, where traders are unwilling to push the price, is likely to be followed by a period of increased movement. The inside bar is therefore telling us that the traders are waiting before deciding on their next big move.
The occurrence of inside bars in a prolonged trend signify that we should look to trade breakouts and take advantage of the longer term but strong trending moves. A popular strategy in this case is to place a Order Cancels Order (OCO order) which calls for buying the high (if it is broken) and selling the low (if broken) through entry orders. So one should enter an inside bar only on the breakout of the mother bar high or low.
If the low point is broken, the trader can place an order for entry to sell at a price that is slightly lower than the low price, but if the high point is broken, the trader can place an order for entry to buy at a price slightly higher than the high of the previous candle. Inside bars are often an indicator of extended moves and thus are very important indicators for traders thinking of entering into trades when a trend is continuing.
Traders can choose from two different stop loss placements for inside bar set ups. The first and the most commonly used option is to place a stop loss order just above or below the high or low of the A bar, depending on whether you intend to go long or short. The next option is useful when inside bars are preceded by very large A bars. In such a case stop loss should be placed near the A bar’s 50% level or the halfway point between its high and low. This strategy will ensure a reasonable risk reward ratio for the trader.
It should be noted this strategy is best avoided during range bound environments.