Technical analysis of price movements involves the use of various candlestick patterns. If you are a short-term trader keen on leveraging immediate market changes, you need to understand how to use strategies based on candlesticks. The inside candle strategy is one such technique.
In this article, we explain the meaning of an inside candle, explore how it is identified, and see how you can trade using the inside candle strategy.
What is an inside candle?
An inside candle is a candlestick whose real body is entirely contained within the real body of the previous candle. Sometimes, this pattern may be used to refer to a candle whose entire body (including the wicks) is engulfed within the preceding candle’s body. The first (or preceding candle) is called the mother candle, and the second (or succeeding) candle is the inside candle.
Identifying and interpreting an inside candle on price charts
To implement an inside candle strategy effectively, you must first learn to identify and interpret the said candle. Here are some indicators or characteristics to look for to confirm the presence of an inside candle.
1. Size and position
The inside candle is always smaller than the mother candle. The opening and closing prices of the inside candle both fall within the opening and closing price ranges of the mother bar. However, depending on these values, the inside candle may be enclosed within the upper, middle, or lower part of the mother candle.
2. Number of candles
An inside candle strategy takes into account the mother bar, the inside candle(s), and the succeeding candle. There may be one or more inside candles that the mother candle encloses. The higher the number of inside candles, the more indecision there is in the market.
3. Direction
Inside candles can form in any market direction — upward, downward or sideways. To interpret them for your inside candle strategy, you need to look into the prevailing trend and the market phase in which the pattern appears. An inside candle cannot indicate anything on a standalone basis.
Types of inside candles
Inside candles can differ based on the direction of intraday price movement. They can be either bullish or bearish inside bars, as explained below.
1. Bullish inside candlestick
Active traders employing technical analysis methodologies frequently utilize candlestick patterns for market interpretation. One such pattern is the bullish inside candlestick.
To qualify as a bullish inside candlestick, the following conditions must be met:
- The closing price of the candlestick is higher than its opening price.
- The candlestick forms within a clearly established uptrend.
When these criteria are satisfied, the pattern suggests potential upward price momentum. Forex traders often employ long or buy positions in response to this bullish signal.
2. Bearish inside candlestick
Conversely, a bearish inside candlestick indicates potential downward price pressure. The defining characteristics of a bearish inside candlestick are:
- The closing price of the candlestick is lower than its opening price.
- The candlestick forms within a clearly defined downtrend.
Typically, a bearish inside candlestick emerges within a broader bearish market context. Traders may implement sell-side strategies in response to this pattern.
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Trading the inside bar candle pattern
The inside bar candle pattern is a valuable tool for traders seeking to identify potential price movements. While its application in trending markets is relatively straightforward, recognizing and profiting from inside bars in counter-trend scenarios requires greater experience.
Due to the prevalence of inside bars on lower timeframes and their propensity for false breakouts, the daily timeframe is generally preferred for their analysis. It is important to note that multiple inside bars can form within a single larger candle, indicating extended periods of consolidation that often precede significant price breakthroughs.
To effectively trade inside bars, traders should focus on identifying them on the daily chart within the context of the prevailing trend. This pattern is particularly noteworthy as it can evolve into other significant price action formations, such as pin bars and fakeies.
A key advantage of inside bar trading is the potential for favourable risk-reward ratios. These patterns often provide clear stop-loss levels and can lead to substantial price movements when a breakout occurs.
It is essential to practice recognizing and analysing inside bars before initiating live trades. A solid understanding of their formation and implications is crucial for successful implementation.
Tips and strategies of inside bar candlestick pattern
An inside candle strategy is subjective and varies based on the prevailing trend, preceding and succeeding candles and other accompanying indicators. The more confirmation you seek before entering a position, the more reliable your reading of the inside candle may be.
Here are some tips to improve the reliability of the inside candle strategy and trade this pattern effectively.
1. Breakout plays
- Inside bars can be traded in the direction of the overall trend (breakout plays).
- A buy stop order is placed above the mother bar's high, and a sell stop order below the mother bar's low.
- Once the price breaks out, the order is triggered.
2. Reversal plays
- Inside bars can also be traded against the trend (reversal plays), especially at key support or resistance levels.
- This requires more skill and practice.
Inside bar characteristics and considerations
1. Mother Bar Size
- Larger mother bars often lead to larger breakouts.
- Stop-loss can be placed at the opposite end of the mother bar or halfway point.
2. Timeframe
- Inside bars are generally more reliable on higher timeframes like the daily chart.
- Smaller timeframes can be noisy with many false breakouts.
3. Multiple inside bars
- Sometimes, multiple inside bars form within a mother bar (coiling inside bars).
- This often indicates a prolonged period of consolidation and potentially a larger breakout.
4. Risk-reward
- Inside bars often offer favourable risk-reward ratios due to tight stop-loss placement and potential for large price movements.
Additional tips
1. Practice: It's essential to practice identifying inside bars on charts before live trading.
2. Other patterns: Inside bars can be part of other price action patterns like pin bars and fakeys.
3. Trading psychology: Successful inside bar trading requires patience and discipline.
Remember: These are general guidelines. Experienced traders may use different entry and stop-loss techniques.
Pros of inside day candles
- Prevalence: Inside day candles occur frequently across various asset classes, from stocks to cryptocurrencies.
- Trading opportunities: The formation presents opportunities for both buying and selling, enhancing a trader's strategy options.
- Versatility: The pattern can be profitably traded in both trending and ranging market conditions.
Cons of inside day candles
- Trading challenges: Successfully trading inside day candles can be complex and costly.
- False signals: In sideways or flat markets, inside candles often produce misleading breakout signals.
- Time-consuming: Profitable or losing trades can take considerable time to materialize, draining capital and potentially leading to missed opportunities.
- Cautionary note: While widely used by technical traders, the inside day candle should be carefully considered before integration into a trading strategy.
Conclusion
An inside candle is a common occurrence in price charts. As mentioned above, one mother candle may also engulf more than one inside candle. So, to implement an inside candle strategy effectively, it is crucial to wait for confirmation and see how the security performs in the trading session following the last inside candle. For added reliability, you can use indicators like trading volume, moving averages, Bollinger Bands, and more.
