How to Identify and Trade Bar Patterns

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Contributor, Benzinga
August 14, 2023

For those interested in using technical forex trading methods in their strategies, mastering the art of candlestick pattern recognition can be the key to unlocking numerous profitable trading opportunities. 

Among the many candlestick formations forex traders can watch for, the inside day or inside bar pattern stands out as a particularly easy-to-recognize and useful one that reflects a moment of equilibrium between buyers and sellers. 

In this article, Benzinga will help you identify and understand the nuances of this useful and common candlestick formation as well as explain how to use it effectively in trading strategies that harness its potential. 

If you’re an aspiring forex trader looking to elevate your trading game, read on to learn more about how the inside bar pattern can offer early insights into potential market continuations and breakouts. 

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What Is the Inside Bar Pattern?

The inside day or inside bar candlestick pattern is a relatively common candlestick chart formation that has become a cornerstone of the particular type of forex technical analysis routinely performed on candlestick charts. It generally manifests as a compact arrangement where the entire exchange rate range of one candle is contained within the preceding candle’s range. 

Visually, the inside bar pattern appears as a smaller “baby” candle nestled safely inside the boundaries of the larger “mother” candle that precedes it. The contrasting size reflects the existence of a temporary equilibrium between bullish and bearish forces in the forex market, and it often hints at an impending exchange rate move in the same direction as the prevailing trend. 

Keep in mind that the inside bar pattern generally serves as a continuation pattern, which means that the pattern is bullish in an uptrend or bearish in a downtrend.  It provides forex traders with a unique snapshot of a moment when the currency market takes a short breather before deciding to continue its prevailing directional bias or market trend.  

Identifying the Inside Bar Pattern on Forex Charts

Discerning the inside bar pattern among the sea of candlesticks seen on a forex chart typically requires a keen eye for detail and an understanding of its defining characteristics. This pattern is sometimes also called the abandoned baby candlestick pattern because of its shape, which looks a bit like a mother candle next to a baby candle.

Identifying the existence of an inside bar formation demands that a higher low and a lower high be seen in the second inside bar or baby candle than in the previous or mother bar candle, as shown in the image below. 

Inside-bars.png

Examples of bullish and bearish inside bar patterns. Source: MySAR Academy.

This means the second baby candle is smaller and completely engulfed by the initial larger mother candle. To give the strongest signal, the inside bar candlestick’s body should preferably be less than half the size of the initial or mother candle’s body. 

The narrower exchange rate range seen in the second candle of this formation signifies a consolidation phase characterized by a contraction in volatility. This formation underlines the existence of market indecision and a general standoff between buyers and sellers in the forex market. 

Overall, the inside bar pattern serves as a continuation pattern that effectively reflects a temporary cessation of significant forex market movement in a prevailing trend. Currency traders must also be astute in differentiating between genuine inside bars and mere consolidation phases because the latter events may not exhibit the same potential for impending breakouts or continuations as the inside bar does.

Inside Bar Pattern Trading Example

For an example of trading the inside bar pattern, consider the situation where a technical forex trader is perusing a forex currency pair’s chart. They note that the prevailing trend is an uptrend marked by successive higher highs and higher lows in the exchange rate. 

The trader then astutely observes an inside bar pattern that is characterized by an initial broader mother candle and a second baby candle with a smaller range and more subdued volatility compared to the preceding candle. Because the trader is well-versed in reading the language of candlestick patterns, they recognize this inside bar as a potential sign that the market will continue in its previous move once a breakout occurs. 

Armed with this insight, the trader patiently awaits the decisive break of the inside bar’s upper or lower boundaries to confirm that the forex market’s indecision has ended. If the prevailing direction of the market’s trend is upward, then a compelling opportunity to enter into a long position using a high-probability trade setup emerges. 

Furthermore, the trader wisely decides to manage the risk involved in taking this position by placing a stop-loss sell order safely back within the narrower range of the second baby candle of the inside bar pattern. They may also decide to put their take-profit order below one of the nearby resistance levels observed on the chart once their preferred risk-reward ratio of 2:1 has been achieved. 

Tips for Trading the Inside Bar Pattern in Forex

Incorporating the inside bar pattern into your forex trading strategy generally requires a disciplined approach and a well-thought-out methodology. By validating signals the inside bar pattern provides with other indicators, practicing prudent risk and money management and combining technical with fundamental analysis, forex traders can use this two-candle pattern more effectively when making trading decisions.

While the inside bar pattern can help forex traders improve their trading strategies, it typically helps to keep some specific tips in mind when using this particular candlestick formation. These include:

Trading Time Frame

Your choice of trading time frame can exert a significant influence on your forex trading outcomes. While the inside bar pattern can show up on candlestick charts across various time frames, its potency and reliability are typically more pronounced when it appears on higher time frame charts, such as the daily or weekly candlestick charts. The extended duration of these time frames boosts the significance of the two-candle pattern, lending credence to its potential for capturing more substantial exchange rate moves.

The Trend is Your Friend 

The perennial wisdom of financial markets traders strongly recommends aligning your trades with the dominant market trend. This general guidance also has value when you plan on capitalizing on the inside bar pattern by including this continuation signal in your forex trading strategy. When observed in the context of a prevailing uptrend in a currency pair’s exchange rate, the bullish inside bar pattern can be a useful harbinger of further upward momentum. Conversely, when seen in a downtrend, the bearish inside bar pattern can signal a continuation of the downtrend.

Identifying the Breakout

The best inside bar setups typically come after a breakout of a consolidation phase. Timing that breakout well and hopping into the market promptly after it occurs can help you optimize profits gained from using the inside bar pattern in your forex trading strategy. Traders should exercise patience and await a clear breach of either the high or low of the inside bar’s range before committing to trade in the direction of the breakout. 

Seek Confirmation

Traders should also implement additional technical indicators, such as momentum oscillators and trading volume, to gauge the strength of and confirm any potential inside bar breakouts. While this might take a bit of extra time before trading execution, seeking confirmation can really enhance the probability of executing a profitable market entry based on the inside bar pattern.

Watch the Fundamentals

While technical analysis offers very useful methods for generating signals and helping traders time their market entries and exits, forex traders also need to keep a sharp eye on market fundamentals. This helps assure them that unpredictable news events and important economic data releases will not occur during the duration of the trade which can potentially result in a sharp adverse market move and unexpected trading losses.

Manage Trades Prudently

Using prudent trade management methods can generally help you conserve your trading capital and improve the safety of your trading strategy because trading without a calculated trade management strategy is akin to navigating treacherous waters without a compass. Techniques to incorporate into your inside bar trading approach include setting realistic take-profit levels and putting protective stop-loss orders safely within the range of the smaller inside bar candle after a breakout has occurred. It also makes sense to size your positions appropriately given your risk tolerance and account size. 

Know Your Risk-to-Reward Ratio

You should really determine the risk-to-reward ratio for any given trade before taking it and resolve to keep your risk to no more than half the potential rewards of a trade. Ascertaining the risk-to-reward ratio for each trade helps ensure that the potential rewards from the trade outweigh the potential risks. A common guideline is to keep the risk per trade at no more than half of the potential reward which implies a 1:2 risk/reward ratio. By adhering to this general principle, forex traders can safeguard their account capital while optimizing their profit potential.

Candlestick Size Matters

Candlestick size matters when trading the inside bar pattern. A modest inside or baby bar that is characterized by a smaller body and a narrower trading range should boost the pattern’s signal that a consolidation phase exists. Conversely, a larger inside bar hints at a more substantial struggle taking place between forex market forces. This situation can potentially foretell a more forceful breakout to continue the prevailing trend when it materializes.

Should Forex Traders Use the Inside Bar Pattern?

For technical forex traders trained to identify it, the inside bar pattern offers a testament to the dynamic interplay of market forces during a period of consolidation. By grasping the nuances of this pattern and using it along with a comprehensive and well-tested trading strategy, forex traders can harness its potential to help them make better and more precise trading decisions. 

As the forex market shifts day in and day out, the inside bar pattern offers traders a useful tool with which to obtain a glimpse into the currency market’s psychology. By carefully identifying this common candlestick chart continuation pattern, forex traders can harness its potential to predict consolidation breakouts within an overall exchange rate trend.

Remember that no trading strategy is infallible and that the inside bar pattern is just one instrument in a trader’s arsenal. It can enhance your trading results when used in conjunction with other tools, prudent risk and money management methods and a thorough understanding of market dynamics.

Frequently Asked Questions 

Q

Is the inside bar pattern bullish or bearish?

A

The inside bar pattern can be both bullish and bearish, depending on its context within the prevailing market trend. A bullish inside bar forms within an uptrend and suggests a potential continuation to the upside after a pause, while a bearish inside bar occurs within a downtrend and hints at a possible continuation of the prevailing decline after a period of consolidation.

Q

What is the win rate for the inside bar strategy?

A

The win rate of the inside bar strategy can vary based on market conditions and the trader’s skill in identifying valid setups. While no fixed win rate for the pattern exists, traders often achieve higher success rates when the inside bar pattern is used in conjunction with a robust trading strategy and other confirming signals as well as prudent risk and money management methods.

Q

Does the color of the inside bar matter?

A

No, the color of the inside bar itself is not a primary determinant of its significance. Instead, the positioning of the inside bar within the prevailing trend and the subsequent breakout direction hold more weight in assessing its potential impact on market movements.

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About Jay and Julie Hawk

Jay and Julie Hawk are the married co-founders of TheFXperts, a provider of financial writing services particularly renowned for its coverage of forex-related topics. With over 40 years of collective trading expertise and more than 15 years of collaborative writing experience, the Hawks specialize in crafting insightful financial content on trading strategies, market analysis and online trading for a broad audience. While their prolific writing career includes seven books and contributions to numerous financial websites and newswires, much of their recent work was published at Benzinga.