How to Trade Profitably with Inside Bars Trading with inside bars is a very popular trading method because it is believed to a be an excellent way to find high reward, low-risk trade entries. Yet many traders find they fail with this method. Does it really work well, and are there any ways to make it work better? Traditional Inside Bars Trading Method The traditional trading method of using inside bars to find trade entries is quite simple. In the first step, you wait for an inside bar (or candlestick if you prefer, they are the same thing) to form). What is an inside bar? An inside bar is a bar with a lower high and a higher low than the immediately preceding bar. It is called an “inside bar” because its range is “inside” the previous bar. An example of an inside bar formation is shown below. Once the bar has formed, it is time for the second step. A buy stop order (a long trade entry) is placed just a fraction (let’s say one pip) above the high of the inside bar, with the stop loss placed just a fraction (again let’s say one pip) below the low of the inside bar. An opposite order is placed at the same time: a sell stop order (a short trade entry) is placed just a fraction (let’s say one pip) below the low of the inside bar, with the stop loss placed just a fraction (again let’s say one pip) above the high of the inside bar. Then, price movement will eventually trigger one of the entry orders, at which point the opposite reverse trade should be cancelled. For example, if the price goes at least one pip above the high of the inside bar, a long trade is entered, with the stop just below the inside bar, and the short trade entry is cancelled. To be valid, an entry must be triggered on the very next candle. In the diagram above, a short trade entry would have been triggered, as the price broke below the low of the inside bar, and the high of the inside bar was never broken. A slight variation on this method which is also popular, is to place the stop loss on the other side of the “mother” bar (the bar just before the inside bar). This means that the entry is the same, but the stop loss is always wider. We will look later at whether this is a good idea, but we will stick with the method as originally described for the time being. Inside Bars Trading Method Back Test Is this traditional inside bar trading method any good? Is it profitable and worth following? The best way to answer this question is to conduct a back test using historical price data. I took the 3 major currency pairs (EUR/USD, GBP/USD, and USD/JPY) which together account for more than 80% of the traded volume of the global Forex market. I used the daily time frame as a starting point, from the start of 2001 to the end of 2017: a period of 16 years, which should be long enough to give a statistically significant result over many hundreds of trades. As explained in the previous paragraph, there was no directional bias: if the first break of a daily inside candle is bullish, a long trade was taken within the test; if the first break was bearish, a short trade was taken. The results were measured at different reward-to-risk “expectancies”, representing the ratio of the profit target to the size of the stop loss. For example, if a stop loss is 40 pips, an expectancy of 1:1 is a profit of 40 pips, 3:1 is a profit of 120 pips, etc.
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