The Inside Day Chart Pattern and Trading Strategy
The Inside Day Chart Pattern, also known as the inside bar pattern is one of the candlestick or bar patterns that has the potential for a break out. The inside day or the inside bar pattern might seem similar to the harami pattern that is found in the candlestick charts. This pattern holds its importance as it can crucially signal which way the markets will move next. Many traders mistake the inside day or the inside bar pattern as a reversal pattern. This is partly true. However, most of this is based on the following price action which determines the breakout and the near term direction in prices.
As a trader, it is important to understand the inside day pattern as it is a commonly recurring theme in the forex markets. For example, on a typical Monday when the economic calendar is quiet, you can often see that the markets (different currency pairs) often trade in an inside day pattern. Understanding how the inside day pattern works can be of great significance for traders as it can hold potential clues to expect what comes next. In this article we will take a closer look at the inside day or the inside bar chart pattern.
How is the Inside Day Chart Pattern formed?
As the name suggests, the inside day pattern forms when price action during the day is confined to the ranges of the previous day’s session. As the name suggests, the inside day pattern is applicable on the daily charts. For further consideration, traders look to the highs and lows and not the open and close. Thus, when today’s high and low is confined (and obviously the open and close) within yesterday’s high and low range, it is said to be an inside bar.
The first chart below, Figure 1 shows a typical inside day pattern. You can see how the current session has been confined to the previous day’s session. It doesn’t really matter whether the inside day pattern closed bearish or bullish.
What matters to traders is how the price action that follows the inside day forms. Typically, depending on the breakout of the inside day pattern, the general wisdom is that price will continue in the same direction. However, make no mistake that you should be cautious. Because of the popularity of the inside day pattern, you can often see false breakouts, or fake-outs following which price completely reverses directions. By doing so, the market captures the weak positions which can often result in losses.
So How Can One trade the Inside Day Bar?
The basic premise is that once the range is established after the inside day pattern is formed you simply trade in the direction of the breakout (with validation from other indicators or support and resistance levels). The entry is usually placed at the close of the breakout with stops placed a few pips away from the high or the low. For take profit, you can either set a 1:2 risk/reward set up or use a pivot level or support and resistance level to book your profits.
Inside Day Bar at the top of the uptrend
When an inside day bar occurs at the top end of the trend, based on the volume, you can expect to see a correction taking place. When there is no valuable information such as volume, you can often refer to other indicators. For example, bearish divergence or a hidden bearish divergence accompanying an inside bar near a previous resistance level can reveal key information to the trader who pays attention.
Thus, when you combine the information such as the divergence, the resistance level and the inside day pattern you can expect price to reverse and decline. But once again, this is not always the case because price can often post a fake out to trap the positions. In Figure 2, you can see an example of the inside day pattern that was formed after the top end of the rally. Here, after a strong rally, the market posted an inside day pattern. This was followed by another session that was close to another inside day pattern.
Eventually, price falls sharply after the breakout from the low of the engulfing bar. What the above inside day pattern tells you is that price action was ready for a correction following the downside breakout.
Inside Day Bar at the Bottom of a Downtrend
An inside day bar at the bottom of a rally can signal a potential reversal or a correction on an upside breakout. However, one should not assume that just because an inside day pattern emerged that prices will reverse. Sometimes you can expect a downside breakout which could signal continuation to the trend.
In figure 3, we have an example of an inside bar breakout at the bottom of a downtrend. Here, you can see that price remains tightly range bound with the previous high and low. But then a strong upside breakout signals the change of the trend as price rallies strongly thereafter.
You can also notice that price briefly declined below the low of the range but quickly recovered. Thus, traders who did not wait for a confirmed close below the low would have seen quite some losses.
In conclusion, the inside day pattern or the inside bar pattern is simply an engulfing bar followed by another session whose high and lows are contained within the previous session. This pattern is very simple and easy to understand. It can quickly yield tremendous profits within a short span of time if applied correctly and validate by other indicators.
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