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Saturday 21 July 2018

How to Trade the Inside Bar Pin Bar Combination

Before we get into how to trade the inside bar pin bar combination, it’s important to fully understand why it works so well. To do this we’re going to break it apart and discuss each piece individually.
First up is the inside bar.
The inside bar is most commonly known as a continuation pattern. It is often found immediately following a large move up or down and represents a period of consolidation where traders “jockey” for position. This stalemate between buyers and sellers is what keeps the price contained within the mother bar.
The inside bar is a strategy that is most effective on the daily time frame. Anything lower and you end up with a lot of false signals.
The trade opportunity comes on a break of the mother bar high or low depending on the orientation of the setup. For example, a bullish setup would call for a break of the mother bar high while a bearish setup would call for a break of the mother bar low.

The second half of the combination is the pin bar. Unlike the inside bar, the pin bar is a reversal pattern that forms as a result of an aggressive push by market participants.
The pattern is often found at key levels in the market, which makes it a great way to identify a potential reversal. The trade opportunity comes in one of two forms – a 50% entry or on a break of the nose of the pin bar.

The Best of Both Worlds

Remember how I mentioned that the inside bar is most commonly known as a continuation pattern? Well, there’s a caveat to that statement.
The caveat is that in order for the market to continue, it has to have room to run. In other words, a bullish inside bar cannot have a resistance level nearby just as a bearish inside bar cannot have a support level nearby.
If this is the case, there is a strong chance the market will reverse rather than continue, which brings us to the inside bar pin bar strategy.
Think of it as a false break of an inside bar. More often than not, when you have a false break of any kind, the market continues in the opposite direction. For example, a false break of a key resistance level will often result in a steady decline shortly thereafter.
The inside bar pin bar combination is no different. To further explain the dynamics at work, let’s take a look at how and why this pattern forms.
The image above illustrates how all three pieces of the pattern work together simultaneously. The first being the key level, followed by the inside bar and then the pin bar.
The inside bar represents the stalemate between buyers and sellers. The ensuing bullish pin bar represents the false break of the inside bar and the key support level. This aggressive push higher to hold support is what gives credence to the reversal pattern.
Note: The bearish inside bar in the illustration above would not have been considered tradable due to the key support level just below it.

The 3 Ingredients of a Valid Inside Bar Pin Bar Setup

Like any of the strategies we trade here at Daily Price Action, there are certain characteristics that determine whether or not a setup is valid. The inside bar pin bar combination is no exception.
Below are three things that must be present in order for this pattern to be considered tradable. These are in addition to the actual inside bar and pin bar, which are of course mandatory.

1) Time Frame

First and foremost, the pattern must form on the daily time frame. This is because the inside bar, which makes up half the pattern, is only valid on this time frame.
Anything lower than the daily time frame is likely to result in a false break and should therefore not be traded.

2) Key Level

The next and perhaps the most influential characteristic is the key level. The entire premise of this pattern relies on a key level of support or resistance. It’s what gives validity to the pattern.
I strongly advise only taking setups where there is a key horizontal level or trend line acting as an inflection point in the market. This will also help you to decide if a setup has become unfavorable.

3) Mind the Close

This next one is a bit different from how we trade a typical pin bar setup. The difference here is that the close of the pin bar must be contained by the range of the inside bar. The only exception here is if you get a “strong” close whereby the pin bar engulfs the inside bar in a way that is favorable for the setup.
The image below explains this in more detail.
The image above shows two valid setups and one invalid setup. Notice how the first image shows a pin bar where the open and close are contained within the range of the inside bar. This represents a valid setup and is also the most common among the three.
The second image shows a pin bar that closed above the inside bar’s high. This is still a valid pattern because of the strong close by the bulls. So strong in fact that it formed a bullish engulfing pattern as a result.
Last but not least is the invalid pattern. Notice how the pin bar failed to close within the range of the inside bar. This is considered a weak close as it signals that the bulls are not in full support of a move higher. It’s generally best to walk away when you see this happen.

Pro Tip: The easiest way to avoid unfavorable inside bar pin bar combinations is to only trade the obvious setups. If you have to study the market for an extended period of time to determine if a setup is favorable or not, it probably isn’t worth taking.

Entry Strategy and Stop Loss Placement

The entry and stop loss placement for the inside bar pin bar combination are very similar to that of the pin bar strategy. In fact, they are exactly the same.

Entry

Option #1: Use the 50% entry strategy whereby you enter on a 50% retrace of the pin bar. This is my preferred method as it provides me with a much more favorable risk to reward ratio.
Option #2: The second and less favorable option is to enter on a break of the nose of the pin bar. Entering this way gives you a less favorable risk to reward ratio.

Stop Loss Placement

As with the traditional pin bar strategy, the stop loss should be placed above or below the tail of the pin bar. If the market reaches this area, the pattern is compromised and the setup is no longer valid.
See The Definitive Guide to Choosing a Stop Loss Strategy for more information on the topic.

The Strategy in Action

We’re going to finish off the lesson by looking at two inside bar pin bar combinations that occurred in the market. Both of these setups were highlighted as they formed inside of the Daily Price Action private community.
The first setup formed on AUDNZD during a downtrend after the pair broke a key support level that had been in place for eight months.
Notice how after breaking trend line support, AUDNZD formed a bearish inside bar. The pair then retested former support as new resistance the following day and carved out a well-defined bearish pin bar in the process.
By using the 50% entry strategy we were able to secure an entry with a 45 pip stop loss. The trade is currently 160 pips in profit and still going. That represents a 3.5R trade, or 7% profit if risking just 2%.
Next up is an inside bar pin bar setup that formed on USDCAD within a ranging market. This illustrates the power of this strategy in that it can be successfully traded in both trending and range-bound markets.
Prior to forming this range, USDCAD had been in a strong rally for more than eight months, creating a broader bullish sentiment. The setup we traded formed after trend line support had held on four separate occasions.
By using the 50% entry strategy we were able to enter long with a 70 pip stop loss. The profit target was easily identified at recent highs, which resulted in a 300 pip profit. That represents a 4R trade, or 8% profit if risking 2%.
Not bad for three days of not working.

Summarizing the Inside Bar Pin Bar Strategy

The inside bar pin bar combo can be a great addition to your trading arsenal. It’s very similar to the traditional pin bar strategy, only it comes with a second dimension that makes it even more reliable.
One thing to keep in mind as you begin trading this combination is that they don’t occur nearly as often as the traditional pin bar setup. However, when they do occur at a key level with a favorable risk to reward ratio, they are certainly worth considering.
Below you will find some of the key points to keep in mind as you begin to trade this pattern on your own.
  • The pattern is created when a pin bar forms immediately following an inside bar on the daily time frame
  • The three ingredients for a valid pattern are the time frame, key level and the close of the pin bar
  • Any pattern that forms on a time frame lower than the daily should be avoided
  • A key horizontal level or trend line gives credence to the pattern and is therefore required
  • The pin bar must close within the inside bar’s range or show a “strong” close in the direction of the setup
  • Only trade the obvious setups where the tail of the pin bar is pronounced
  • The 50% entry is the most favorable way to enter the market

Your Turn

Are you currently trading something similar? If not, do you see yourself trading the inside bar pin bar combination in the future?
Leave your comment or question below. I promise to respond within 24 hours.

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