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Inside Bars – The Hidden Price Action Driver
Strangely, many aspects of trading analysis are not necessarily based on what is happening, but on what is not happening.
If you’ve heard of traders shorting the VIX, that’s somewhat relevant. Traders wait for volatility to spike, and once it reaches a certain level, usually around 30 or 35 on the VIX, they explore bearish strategies under the assumption that volatility will eventually stabilize.
When volatility subsides, option premiums become cheaper due to the lower value of the VIX, which feeds into the Black-Scholes option pricing model. At this point, traders can use lower volatility levels to look for a breakout, or trade a cross while looking for volatility and then extend it. Therefore, in this case, volatility is seen as a cyclical tool that rises and falls, and traders often try to position themselves on the other side for maximum benefit.
Inside bars are closely related in terms of price action, and many traders ignore these patterns – or “missing patterns” – and wait for some kind of more actionable signal. But the reality is that when they do, these can be powerful indicators, and we’ll take a closer look in this episode.
What is the Inside Bar
Inside bars are the exact opposite of engulfing candlesticks. The inner column is printed completely inside the previous column. This illustrates a form of balance in the market – and traders can take advantage of this. Unlike Engulf, however, there is only one type of interior line – it must be printed exactly in the previous formation. There may be no wick penetration on the previous bar, or we may not have the balance traders are looking for in this pattern.
GBP/JPY daily chart
In the chart above, you’ll notice that I’ve pointed out five different inner bar patterns in the GBP/JPY daily rate. Each of these daily bars stays completely within the previous day’s range – making it an inside bar representing an “inside day”.
But – the more interesting part is what happens after each one…
How to Work with Inside Bars
Some subjectivity is required here. There may be some suboptimal situations where the inner lines are printed in order, or worse, out of order in the middle of the stamp and range. This scenario could herald a very big central bank meeting, earnings report or interest rate announcement. But the takeaway from this situation is that the market is driven in part by fear, with buyers and sellers worried about being offside too far.
But in a less ominous way, that’s what creates pressure inside, right? This in itself is a form of indecision and a bit of a digestion.
But it’s interesting to see what happens after the inner bars are printed – that’s the possibility of a breakout. In the chart above, this shows that every inside bar printed is followed by a breakout that lasts at least one bar after that. This is of course correct, but the last bar shows a reversal. As the bearish trend began to develop, the inner bar was printed and the low was immediately broken.
Inside Bar Breakouts
At first glance, breaking out of any interior bar can be a daunting task. As such, traders may want to focus their searches for inside bars on longer time frames to ensure they don’t get caught up in a volatile lull.
To use an inside bar, a trader can mark the high and low of the bar and look for a directional breakout. Using the example above, let’s look at the last inside bar that turned into a bearish trend, but I’ll use the short-term chart below, the four-hour chart, to show how this pattern works. The bar’s low was 166.99 on April 21, 2022, while the high was 167.91.
Sellers were forced to rest late in the evening, around 1am the day after the bar closed. The trend then entered an aggressive downward move, which I highlighted with a red box.
But there are other interior bars and not all of them are as good as the last one. On the left side of the chart, we see four additional inner bars and subsequent market movements. It’s worth noting that not everyone entered the aggressive strong trend. The possibility of hacking still exists. But the four inner bars on the left side of the chart are all trend-side; essentially a mechanism to join an uptrend.
GBP/JPY two-hour price chart (Late March 2022 – May 2022)
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