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.
- 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.
- 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.
- 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.
- Bullish inside candle: A bullish inside candle is a green candle representing a trading session when the price opened low and closed high. It typically occurs during an upward trend, although it can also be occasionally found after a red mother candle.
- Bearish inside candle: A bearish inside candle is the opposite of a bullish inside bar. Here, the price closes lower than it opens. Such a candle generally forms during a confirmed bearish market, although it is possible to have a red inside candle within a green mother bar.
Inside candle strategy: Tips to trade a bullish or bearish inside candle
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.
- Look for breakout confirmation: If you spot a bullish inside candle, wait for a bullish breakout where the price rises past the high of the inside candle or the mother bar. In the case of a bearish inside candle, you need to wait for the price to dip beyond the low point of the inside candle or the mother bar.
- Evaluate trading volume: If the breakout is accompanied by rising trading volume, the confirmation is considered to be stronger.
- Set your entry points: To catch a bullish breakout, you need to enter the market at a price slightly above the high of the inside candle or the mother bar. Conversely, to catch a bearish breakout, set an entry below the low price of the inside/mother candle.
- Set stop-loss limits: Stop-loss limits help you reduce the downside risk in case the market moves in an unfavourable direction. In a bullish inside candle strategy, your stop-loss limit must be just below the low price of the inside or the mother bar. In a bearish inside candle strategy, the stop-loss order should be set just above the high of either candle.
- Have target profits in mind: In any inside candle strategy, your target profits are best determined based on the support or resistance levels, risk-reward ratio, Fibonacci extensions or retracement and other technical indicators.
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.
