The Definitive Guide to Trading Inside Bars

Here’s a question for you…

If you compress a spring between your two fingers and then let it go, what will happen?

It will bounce off with great velocity.

That’s what Inside Bars can do when you find the right setup.

And that’s the reason why many traders like to trade it.

It’s meant to represent a breakout in price.

And as we all know, breakouts mean you can hit your profit target faster.

But there’s a catch…

And the catch is that it’s not that simple with Inside Bars.

Because if it were, everyone just has to trade Inside Bars and they would be profitable right?

But that’s not the case.

That’s why I’ve created this guide to help you navigate your way to trading Inside Bars reliably and profitably.

So first and foremost, you need to know…

What Exactly is An Inside Bar?

An Inside Bar is a candlestick that is formed within the high and low of the previous bar.

Hence the name.

 

This is a two-candlestick pattern formation.

The Inside Bar does not necessarily have to look like the one in the picture above.

As long as it is inside the previous bar, it’s considered an Inside Bar.

Now, there are a few names for this previous bar.

Some call it the “Preceding Bar”.

And some call it the “Mother Bar”, with the Inside Bar being the “Baby Bar”.

I like just calling it the Previous Bar because that’s what it is.

So throughout this whole post, I’ll be calling it the Previous Bar.

The Significance of Inside Bars

Inside Bars is a sign of compression or low volatility.

Like I mentioned at the beginning of this guide, an Inside Bar is like a spring.

So it is a sign that the market might be about to breakout.

And by “breakout”, I mean a forceful move either up or down in price that creates a long candlestick bar.

Hence, many traders coin the term “Inside Bar Breakout”.

But do not let the term “breakout” fool you.

That’s because many times, it’s just the market moving out of the boundaries of the Inside Bar.

So it may not be a breakout, but just a normal and gradual move out of the Inside Bar’s range.

To give you a better understanding of this, you need to understand how an Inside Bar is formed.

How Are Inside Bars Formed

Take a look at the Daily chart of this Inside Bar below:

Now let’s zoom in to the 1-hour chart to see exactly what is happening.

You can see in the chart above, the candlesticks in the red box form the Previous Bar.

And the candlesticks in the green box form the Inside Bar.

Can you see that there is really nothing “spectacular” in the movement when you see what makes up an Inside Bar?

The formation of the Inside Bar above is pretty much just a retracement on the 1-hour chart.

On top of that, if you noticed, there are also a number of Inside Bars forming inside this Inside Bar.

So what this tells us is that Inside Bars aren’t some magical candlestick pattern that will miraculously work each time we trade them.

And that’s the same with ANY candlestick pattern.

You do NOT want to trade any candlestick pattern by itself.

Candlestick patterns are not trade setups.

That means you do not go Long or Short purely on see any candlestick pattern.

But rather, it should serve as a trade entry of your trading setup.

And this brings me to my next point, and that is…

How NOT to Trade Inside Bars

The fastest way to lose all your money in your trading account is to trade every single Inside Bar you see.

Take a look at this chart below:

There are AT LEAST 13 Inside Bars in the chart.

You can see in the chart above that after identifying 13 Inside Bars, I have given up counting.

And if I’ve given up counting the number of Inside Bars there are on the chart, it would be ridiculous to trade every single Inside Bar.

So you definitely do not want to trade an Inside Bar just because you see it formed.

I know of people who just “straddle” every Inside Bar they see.

That means to buy when it breaks above the high, and to sell when it breaks below the low.

That’s suicide.

Now, the other way to not trade Inside Bars is when the market is in a range.

In the same chart above, you can see that the market is going sideways.

If you trade an Inside Bar when the market is going sideways, you will get chopped up very badly.

So as always, you want to identify the context by which the Inside Bar is formed.

And if you’re just getting started trading the markets, then you only want to trade in the general direction of the market’s trend.

If the market is in an uptrend, then you only want trade to go Long.

And if the market is in a downtrend, then you only want to go Short.

Only once you’ve gotten more experience trading the markets, then you can consider counter-trend trading strategies.

How to Enter Into A Trade With Inside Bars

First of all, let’s get into how you enter a trade for an Inside Bar.

Then we will get into the specific trade setups.

There are 3 methods to enter into a trade using Inside Bars.

1) Method 1 – Previous Bar Entry

For this method, we will be using the Previous Bar to determine our entry point.

To go Long, wait for the market to break above the high of the Previous Bar.

So we place a Buy Stop Order above the high.

And we place our Stop Loss below the Previous Bar’s low.

Take Profit will be at either 1.5R or 2R, which means a 1:1.5 or 1:2 risk-to-reward ratio.

So if the distance from the entry to the Stop Loss is 20 pips, then the Take Profit level will be either at 30 pips away for 1.5R…

Or at 40 pips away for 2R.

To go Short, we wait for the market to break below the low of the Previous Bar.

Then we place our Stop Loss above the Previous Bar’s high.

Take Profit will also be at either 1.5R or 2R.

2) Method 2 – Inside Bar Entry

This method uses the Inside Bar for our entries.

To go Long, we wait for the market to break above the high of the Inside Bar.

Then we place our Stop Loss below the Inside Bar’s low.

Take Profit will be at least 2R.

Now, you might be wondering why is the Take Profit different from the Previous Bar Entry?

That’s because, with the Inside Bar Entry, you tend to get more false breakouts as it’s range is smaller than the Previous Bar.

A false breakout is when the market breaks either the high or low of the Inside Bar, and then quickly reverses back to the other direction.

Because of this, we ideally want a bigger Take Profit level to compensate for the more frequent stop-outs.

Furthermore, because the range of the Inside Bar is smaller, for the same Take Profit level, you would be making more.

Here’s what I mean…

In the Previous Bar example, the Stop Loss is 20 pips away and the Take Profit at 1.5R is 30 pips away.

With an Inside Bar Entry, the Stop Loss might just be 10 pips away.

So if you also place a 30 pips Take Profit level, it would be a 3R for the same take profit distance.

Hence you make more because of the Inside Bar’s tighter Stop Loss.

Okay, so to go Short with an Inside Bar Entry, we wait for the market to break below the low of the Inside Bar.

Then place the Stop Loss above the Inside Bar’s high.

Similarly, the Take Profit will be at least 2R as well.

3) Method 3 – Hybrid Entry

For this method, it’s a hybrid of the first two methods.

That means our entry will be based on a combination of the two bars.

So for a Long Entry, we place the Buy Stop Order above the Inside Bar.

But the Stop Loss will be placed below the Previous Bar.

This will give us a tighter Stop Loss than the Previous Bar Entry but so we can get a better risk-to-reward ratio…

But not as tight as the Inside Bar Entry so we don’t get stopped out as often.

This gives us a nice balance of both entries.

For a Short Entry, we place the Sell Stop Order below the Inside Bar.

And the Stop Loss will be placed above the Previous Bar.

Now you might be wondering, how do you decide which entry to use?

The answer is that it depends on the size of the bars.

If the Previous Bar is only slightly bigger than the Inside Bar, then I’ll use the Previous Bar Entry.

But if the Previous Bar is much bigger than the Inside Bar, then I’ll use the Hybrid Entry.

I don’t use the Inside Bar Entry because it tends to get more stop-outs, and I prefer to have more winning trades than bigger win per trade.

But this is ultimately comes down to the trader’s preference.

So if you don’t mind getting more stop-outs but have a bigger risk-to-reward ratio, then you can go for the Inside Bar Entry.

But if you’re like me, then the Hybrid Entry might be more suitable.

Now that we know how to get into a trade, let’s get into the specific setups where we can use the Inside Bar as an entry.

Trade Setups With Inside Bars

Here are 3 setups that you can use to trade Inside bars.

To trade these setups, you just need 3 indicators on your chart:

• 20 EMA
• 50 EMA
• Stochastic Indicator (this is only for trading the divergence setup)

The Exponential Moving Averages (EMA) are used to identify the trend.

If the 20 EMA is above the 50 EMA, we only want to look for Long setups.

And if the 20 EMA is below the 50 EMA, we only want to look for Short setups.

The stochastic Indicator is just specifically for identifying divergence in our third trading setup.

Setup 1: Pullbacks

Pullbacks happen all the time in the markets and we can utilize the Inside Bar to get into a pullback trade.

To trade pullbacks, we want to first wait for the market to go above both the EMAs in an uptrend or below both the EMAs in a downtrend…

Then wait for it to pullback to either of the EMAs.

We then want to wait for an Inside Bar to be formed on either of the EMAs.

Once the Inside Bar is formed, we place our entry orders accordingly.

Let’s take a look at an example.

In the chart above, you can see the market is in an uptrend and the 20 EMA is above the 50 EMA.

So we are only looking to go Long.

As the market is going up, it went above both the EMAs and made a pullback to the 20 EMA and formed an Inside Bar.

We now have a potential Long trade if the market does not go below the Inside Bar.

At this point when the Inside Bar is formed, we want to place our Buy Stop Order.

Since the Inside Bar is not that much smaller than the Previous Bar, we use a Previous Bar Entry.

So place a Buy Stop Order above the high of the Previous Bar.

And place Stop Loss below the low of the Previous Bar.

Take Profit at either 1.5R or 2R.

Here’s another pullback trade example.

In this chart, there are two Inside Bar trades.

The first trade is when the 20 EMA just crossed below the 50 EMA and the market made a pullback the EMAs.

You can see on the left-hand side of the chart, the market went from an uptrend to a downtrend.

As the market moved below the EMAs, it started to form lower lows and lower highs.

Since the 20 EMA is also below the 50 EMA, we only look for Short entries.

The market then made a pullback to test the 20 EMA and 50 EMA, and formed an Inside Bar.

Since the Inside Bar isn’t that much smaller than the Previous Bar, we use a Previous Bar Entry.

However, for the second Inside Bar, the Inside Bar is much smaller than the Previous Bar.

So for the second Inside Bar trade, we use the Hybrid Entry.

For this, we place the Sell Stop Order below the low of the Inside Bar.

And the Stop Loss is placed above the high of the Previous Bar.

In both cases, the market broke below the low of the Inside Bars and continues to go down.

As you can see, both trades are profitable.

Setup 2: Support & Resistance Levels

The second way to trade Inside Bars is to use it with support and resistance levels.

Support and resistance levels are places where the market can potentially reverse because of a strong opposing buying or selling pressure.

And this is a good place to use the Inside Bar as an entry.

Let’s take a look at an example using the Inside Bar with a resistance level.

In the chart above, you can see that the market is generally trending downwards and the 20 EMA is below the 50 EMA.

So this means that we want to only look for Short trades.

On the right-hand side of the chart, the market went above the two EMAs and tested the resistance level.

The market couldn’t close above the resistance level and it formed an Inside Bar.

This is a bearish sign when the market can’t close above the resistance level.

Once we see the Inside Bar formed, we want to place our orders.

And this case, because the Inside Bar is considerably smaller than the Previous Bar, and it’s also near the top of the Previous Bar, we can use the Hybrid Entry here.

So we place the Sell Stop order just below the Inside Bar and we place the Stop Loss above the high of the Previous Bar.

For trading Inside Bars with support levels it’s just the exact opposite.

We look for a market that is trending upwards and the 20 EMA is above the 50 EMA.

Then we wait for the market to test a support level and see if an Inside Bar is formed.

If so, we simply place our Buy Stop Order and Stop Loss according to the entry that is right for the trade.

Setup 3: Divergence

So previously I mentioned that we only want to trade with the trend.

And that’s because we can be more objective about our entries rather than “straddle” the Inside Bar.

As mentioned earlier, straddling means to place both a buy and sell order above and below the Inside Bar respectively.

I wouldn’t recommend that if you’re just starting out because you can keep getting stopped out if the market whipsaws above and below the Inside Bar.

So we only want to take a trade in the direction of the trend.

If it goes the other way instead and it did work if we traded the other direction, then just move on to another trade.

There will be plenty of setups in the market.

Now, with the Divergence setup, we also want to trade with the trend.

That means we only trade this setup in the direction of the bigger timeframe.

If you’re doing intraday trading, then you might use the 30-minute chart for your entries and the 4-hour chart as the bigger timeframe.

So if the 4-hour chart is in an uptrend, then you only want to go Long.

And if it’s in a downtrend, then you only want to go Short.

And if you’re doing swing trading, then you might trade off the 4-hour chart, and use the daily chart as the bigger timeframe.

Okay, let’s get to the specifics of a divergence setup.

To go Short for a divergence, we are looking for either a double top or a higher high.

In the chart above, you can see that the market has formed a double top.

At the same time, the stochastic indicator is showing a lower high.

This is a divergence.

And as you can see on the right-hand side of the chart, an Inside Bar has formed as well.

Because the Inside Bar is much smaller than the Previous Bar, we will be using the Hybrid entry.

We place a Sell Stop Order just below the Inside Bar and place the Stop Loss above the Previous Bar.

For a Long entry, it’s the exact opposite.

We want to see the market generally trending down and forming either a double bottom or a lower low.

Then when the Inside Bar is formed, we want to see that the stochastic indicator is showing a higher low for divergence.

Then we decide to either choose a Previous Bar Entry or a Hybrid Entry depending on the size of the Inside Bar.

Conclusion

Trading Inside Bars can be very profitable if you trade it the right way.

But Inside Bars is not a trading strategy.

It’s not a trade setup.

It’s just what you use to get into a trade.

Similar to any other candlestick patterns, we do not enter into a trade just because you see a bullish or bearish candlestick pattern.

Instead, we trade the setup.

That means you do not specifically look for an Inside Bar just to get into a trade.

Rather, you look for the specific trade setup, then see if the right candlestick pattern forms to give you an entry signal.

An Inside Bar is just one of them.

And if you trade them accordingly with the right setups, then it can give you high probability trades.

So there you go…

By reading this guide, you should now know exactly when to trade Inside Bars and when to avoid it.

Now go and see if you can find an Inside Bar trade with the setups I’ve shared with you here.

Then let me know in the comments how it worked for you.

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