Inside Bar Forex Trading Strategy

Inside bars are one of my favorite price action setups to trade with; they are a high-probability trading strategy that provides traders with a good risk reward ratio since they typically require smaller stop losses than other setups. I like to trade inside bars on the daily chart time frame and ideally in strong trending markets, as I have found over the years that inside bars are best in trending markets as breakout plays in the direction of the trend. However, they can indeed also be used as reversal signals from key chart levels, we will discuss both in this tutorial. Let’s discuss some facts about inside bars first and then I will go over some examples of how I like to trade them.

What is an inside bar?

An inside bar is a bar (or a series of bars) that is completely contained within the range of the preceding bar, also known as the “mother bar”. The inside bar should have a higher low and lower high than the mother bar (some traders use a more lenient definition of inside bars to include equal bars). On a smaller time frame such as a 1 hour chart, a daily chart inside bar will sometimes look like a triangle pattern.

Important note: Since the inside bar setup is by its very nature a potential breakout signal, I ONLY enter an inside bar on a breakout of the mother bar high or low. If I am looking to buy, I will place a buy on stop entry just above the mother bar high, and if I am looking to sell I will place a sell on stop entry just below the mother bar low.

There are different variations, but the way I determine an inside bar setup is if the inside bar is contained within the range of the mother bar from high to low. That is to say, I use the mother bar high and low to define the range that the inside bar can be contained within, others might use only the real body of the mother candle as the determining range, but I do not teach or trade it that way.

In the example image below, we can see the anatomy of an inside bar setup. Note that the inside bar is fully contained within the range of the high and low of the mother bar. You can have multiple inside bars within the range of one mother bar. If you see a pattern of consecutive inside bars that are “coiling” and all within the previous bar’s range, this can signal that a powerful breakout might be coming, more on this later.

What does an inside bar mean?

The inside bar forex trading strategy is a ‘flashing light’, a major signal to the trader that reversal or continuation is about to occur.

An inside bar indicates a time of indecision or consolidation. Inside bars typically occur as a market consolidates after making a large directional move, they can also occur at turning points in a market and at key decision points like major support/resistance levels.

They often provide a low-risk place to enter a trade or a logical exit point. In the image you will see next, we see an example of inside bars that formed as a continuation signals and then one that formed as a turning point signal. While they can be used in both scenarios, inside bars as continuation signals are more reliable and easier for beginning traders to learn. Turning-point, or inside bar reversal signals, are best to leave alone until you have some solid experience under your belt as a forex price action trader.

How to trade the inside bar setup

There are basically two ways to trade an inside bar setup: As a continuation signal or as a reversal signal.

The chart image below has a variety of inside bars for us to pick apart…

First, you will see that we have inside bars that acted as continuation signals, that is they resulted in a continuation of the previous momentum before their formation. These continuation inside bars often result in nice breakouts in-line with the current trend and near-term momentum.

We can also see a good example of an inside bar that acted as a reversal or turning point signal. Note on the far right side of the chart an inside bar formed at a key support level, the market then broke back the other direction and made a nice move higher from the inside bar / stalling pattern that formed at a previous level of key support.

Important note: There are basically two different stop loss placements for inside bar setups, and you will have to use some discretion in determining the best one for each inside bar you trade.

The “classic” and most commonly used stop loss placement will be just above or below the mother bar high or low, depending on if you are trading long or short of course. I typically go with 1 pip above or below the mother bar high or low…no need to try and figure out the “best” distance above or below the mother bar…the trade either works or it doesn’t, a few pips won’t make that big a difference over the long-run.

The next stop placement is typically used on inside bars with larger mother bars. Although a larger mother bar on an inside bar setup is not really what I like to see, you can sometimes trade inside bars with larger mother bars, and if you do, you will probably want to place your stop loss near the mother bar 50% level, that is the ‘halfway point’ between the high and low of the mother bar, as that is really the only way to get a decent risk reward ratio on these types of inside bar setups.

I prefer smaller and “tighter” inside bars that don’t have really large mother bars…this shows more ‘compression’ and thus a stronger potential breakout from that compression. If you are a beginner or struggling trader, I suggest you avoid inside bars with big mother bars for now, see the previous example chart above for an example of an inside bar with a big mother bar.

Inside bars as continuation signals

The most logical time to use an inside bar is when a strong trend is in progress or the market has clearly been moving in one direction and then decides to pause for a short time.

Inside bars can be used when trading a trend on the 4 hour charts or the daily charts, but I personally prefer to trade inside bars on the daily charts and I recommend all beginning traders stick to the daily charts and until they have fully mastered and found consistent success with the inside bar setup on that time frame. I also recommend sticking to inside bars that are in-line with the daily chart trend as continuation signals until you have fully mastered trading them that way.

In the chart example below, we can see a few examples of inside bar setups on the daily EURUSD chart that worked out quite nicely. They were in-line with the near-term dominant daily chart trend and resulted in nice breakout continuation plays…

Inside bars as reversal signals

You can sometimes trade inside bars as reversal signals from key chart levels. Please note that this should ONLY be tried after you have successfully mastered trading inside bars in-line with the daily chart trend as continuation / breakout plays, as we discussed above.

In the chart below, we can see an example of a good inside bar reversal signal. Of critical importance here, is that the inside bar formed at a key chart level, indicating the market was hesitating and “unsure” if it wanted to move any higher. We can see a decent downside move occurred as price broke down past the inside bar’s mother bar low..

The best time frame for trading inside bars

I really only trade inside bars on the daily chart time frame. There’s good reason for this, and that reason is mainly because on time frames under the daily chart, inside bars simply grow too numerous to be worth trading. There can be long strings of inside bars on a 4 hour or 1 hour chart before a breakout for example, and trying to trade them will most likely cause you a lot of frustration due to all the false breaks that can occur on those chart time frames.

I get a lot of emails about inside bars, and many traders try in vain to trade them on lower time frame charts, and it really is just a huge waste of time. Once you gain experience, you MIGHT be able to trade inside bars on a 4 hour chart time frame, but that is the LOWEST time frame I would ever consider trading an inside bar on. The daily chart is the best for inside bars, and even the weekly chart can sometimes yield some very lucrative inside bar setups.

Inside bars can be used when trading a trend on the 240 minute charts or the daily forex charts, but I personally prefer to trade inside bars on the daily charts and I recommend all beginning traders should stick to the daily charts until they have fully mastered and found consistent success with the inside bar setup on that time frame.

In the chart example below, note how well the inside bars highlighted worked out. They won’t all work out obviously, but inside bars on the daily chart have a much higher probability of bringing you a profit than an inside bar on a lower time frame…

The chart example below shows a recent 1 hour chart of the EURJPY. If you look closely you will see A LOT of inside bars that failed, this is a prime example of why I avoid trading inside bars on the 1 hour chart and also why I LOVE to trade them on the daily chart time frame…