Trading Inside Day False Breakouts

03/04/2015 9:00 am EST

Focus: FOREX

Candle patterns can give visual insight into market psychology and suggest changes in sentiment, which is useful in finding market reversals. Nick Simpson of writes about one of his preferred strategies.

An inside day candle is a setup, which has the current candle engulfed within the prior day's range. This pattern is the opposite of an engulfing candle. Anyone looking to understand the inside day candle pattern should start with the inside bar analysis tutorial, which looks at this popular price action setup in detail.

False Breakout Before The Real Deal
The false break of an inside day price action setup can sometimes be a hint that the break of the other extremity will be the real deal. The following chart excerpt shows an inside day (daily chart) and price initially gives a breakout to the downside.

daily chart

Notice how price did not sustain the downside momentum but actually closed above the inside day low. The next day had a break of the upside and this came with strong momentum-actually marking a significant swing low.

Click to Enlarge

Daily highs and lows are often surrounded by clusters of orders as technical traders look to fade or trade breaks of these levels. If price cannot hold below an inside day-after breaking below (or above if a bullish break is seen)-we are getting a message from the market that the sentiment to push prices in this direction may not be there. Let's now look at this price action setup, in the wider context, on the following chart.

Click to Enlarge

The break of the other side of an inside day, after the false breakout, is a play that some traders (including this one) often prefer than the original break. Let's look at some of the reasons why.

  • If the first breakout is into support or resistance the failure to sustain a move is useful information. The market participants who are protecting the aforementioned support or resistance level have succeeded and price may subsequently move in the path of least resistance (break of the other side of our inside day).
  • If the original break is countertrend the break of the other side may be a play into a trend resumption move.
  • Weak hands could be caught in a bad trade and need to liquidate positions when the opposite extremity is broken, subsequently triggering their stop loss.
  • A trade in the opposite direction of a failed inside day breakout can sometimes be an early entry into an engulfing candle play. Price has moved above or below the prior day's candle and the break of the other extreme is by nature the start of an engulfing pattern. Of course the engulfing pattern will fail if price cannot hold the new highs or lows so discretion is need (as ever).

Ultimately we never know exactly what will happen when we take a trade of an inside bar; however, with the information above in mind, we prefer to take a trade in the opposite direction of a failed breakout. Spend some time testing this strategy yourself, on a demo account, and maybe it will whet your appetite to investigate further.

By Nick Simpson of

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