Trading the Inside Bar Breakout Strategy
Trading markets by using candlestick formations is a popular approach among crypto traders. In the trading process, we often look for logical and profitable trading opportunities. In this blog post we take a closer look at a popular candlestick formation, called the Inside Bar Breakout pattern.
Structure of Inside Breakout pattern
By definition, an Inside Bar Breakout pattern consists of two bars where the inside bar is smaller within the high to low range of the prior bar, i.e. the high is lower than the high of the previous bar, while the low is higher than the previous bar’s low.
As mentioned, the bar on the right is called the inside bar while the first bar is often referred to as “mother bar”. For this reason, you will often see traders referring to these two bars as “mb” and “ib”. The mother bar can be either bullish(green) or bearish(red).
As a general rule of thumb, the mother bar should be bigger than the inside bar. In case you can’t judge if there is a difference between the two bars, as their size is similar, it is best to stay away from such formation. It is crucial for the validation of this formation that the inside bar is formed completely inside the shadow of the mother bar.
Given the structure of this formation on higher time frames e.g. daily/weekly/monthly, usually it looks like a triangle on the lower time frames. As the triangle is defined as a consolidation pattern, the Inside Bar signals the market is consolidating after a volatile day, week, or month, depending on which time frame you spotted this formation. Following every consolidation, a strong move occurs in one direction. This pattern works best on higher time frames, a 4-hour chart or higher.
The Inside Bar Formation signals indecision amongst traders as market participants hesitate to move higher than the previous bar’s high and vice versa. In general, the Inside Bar Formation can be both a reversal and a continuation pattern. In most cases, this pattern occurs as a continuation formation.
Trading the pattern
Bearing in mind its structure, the Inside Bar Formation occurs quite often in the market. We easily spotted this pattern in the Bitcoin daily chart. As a first step, it is important to analyse the prevailing trend in the market. We see in the chart below that there is a clear downtrend in place as the price action moves lower in quite a decisive manner. Secondly, try to locate a two-bar pattern that resembles the aforementioned structure.
On the first occasion, Bitcoin hints it wants to recover strongly as it erupts higher. However, the inside bar signals that there is indecisiveness amongst traders as there is no follow up on the initial move. Ultimately, the price continues to move lower. The breakout occurs when the price leaves the range of consolidation.
Shortly afterwards, we have a similar situation. Again, Bitcoin explodes higher to form a mother bar however, the inside bar signals a reluctance of the price action to progress above the preceding candle high. The bears recognise this opportunity and following two consecutive failures to move higher, they take the price lower to create a fresh short-term low. In this case we identified a “Inside Bar Sell Formation”, given that the prevailing trend is bearish.
In general, the Inside Bar Formation works extremely well in a trending market. Hence, avoid trading this formation when the market is ranging and choppy. A stop-loss order should be placed on slightly beyond the inside candle’s top, or bottom, depending on the direction of the break. One of the greatest advantages of this pattern is that it offers a tight stop loss placement.
On the other hand, there are no clear instructions as to where exactly to place the profit-taking order, as it is the case with stop loss. For this reason, traders often use R:R (risk/reward ratio) to identify a level where will it will be appropriate to take profits off the table. If your trading style applies the conventional 2:1 R:R, than simply calculate your stop loss in pips and double the number to get take profit.
When you are determining the profit-taking level it is always advised to use other indicators since the price action may stop earlier due to an important resistance or support in that area e.g. if 100-DMA sits in a zone where you consider placing the take profit order, then you should consider using this important technical indicator as a price point against which you take profits off the table.