It is a candlestick pattern indeed. Although it is a little hard to see it on the price charts, it is usually very strong in reversing the price.
Whether you like it or not, Bollinger Bands® indicator has an important role in this pattern too. I don’t mean that we have to have the Bollinger Bands on the charts in order to recognize this pattern. What I mean is that Bollinger Bands helps a lot in locating and taking this pattern as a reversal. This is what even the most professional stock traders also admit. They also use the Bollinger Bands to locate and trade the “Inside Day Candlestick”.
What Is the “Inside Day” Candlestick?
Do you remember Harami and Harami Cross patterns? “Inside Day” is exactly the same. In fact, “Inside Day” is the second candlestick (the baby) in the Harami pattern which is engulfed by the previous candlestick (the mother). Like all the other patterns like Dark Cloud Cover, here we need two candlesticks to have the pattern formed. However, with the “Inside Day” pattern, in fact the second candlestick is the “Inside Day” candlestick. American stock traders call the Harami pattern as “Inside Day Candlestick”.
Why the Second Candlestick (the baby) Is Called “Inside Day”?
Those traders who traded the daily chart chose such a name for the second candlestick in the “Inside Day” pattern. Of course you can see the pattern in all time frames, and it works on them as a strong reversal signal too, but it is called “Inside Day” because it was initially used on the daily time frame. I recommend you to trade this pattern on the daily or longer time frames too.
They call the second candlestick as “Inside Day”, because it is small enough to be entirely engulfed by the previous candlestick (the mother in the Harami pattern). It means, the “Inside Day” candlestick high and low prices fall within the high and low price range of the previous day candlestick. The below screenshot shows 4 inside day candlesticks on EUR/USD daily chart. There are a few more inside day candlestick on this screenshot, but I am just showing you 4 of them. See the below screenshot first, and then I we will go ahead with having the Bollinger Bands on the chart:
I believe it is a must to have the Bollinger Bands on the chart, to take the best Inside Day pattern as a reversal signal. And I am not alone. I know so many professional stock and currency traders who emphasize on having the Bollinger Bands on the charts to trade the Inside Day candlestick. Jamie Saettele is one of them.
According to Jamie Saettele, Inside Day works as a good reversal signal when there is a visible Bollinger Upper or Lower band breakout either by the first candlestick (the mother), or the second candlestick (the baby), or preferably both.
He says when the price hits the Bollinger Upper or Lower Band on the daily chart, then we can wait for an “Inside Day” candlestick to form. While the candlesticks are hitting the Bollinger Upper or Lower Band, if a candlestick opens and closes while its high and low price range falls inside the previous candlestick high and low price range, then we have an “Inside Day” candlestick, and we can take a position.
This is how the above chart looks after adding the Bollinger Bands:
According to Jamie Saettele, only the candlestick #1 and #3 should be considered and taken as a reversal signal.
Candlestick #2 formed on Bollinger Middle Band. It reversed the price strongly but it did not follow our Bollinger Bands breakout.
Candlestick #4 and its previous candlestick did not hit the Bollinger Upper Band, and so they have to be ignored (the trade setup is not complete).
The below chart shows two strong Inside Day candlesticks formed consecutively at the bottom of a bear market. It is an interesting screenshot, because it shows one inside day candlestick formed (#1) and then another one formed inside the first inside day candlestick (#2). There is a nice and strong Bollinger Lower Band breakout, both by the first candlestick (the mother), and the first inside day (#1).
There is another inside day candlestick which is marked with ~ on the below chart. Although it is engulfed by the previous candlestick, it has to be ignored because neither the previous nor the inside day candlestick have not hit the Bollinger Lower Band:
How to Trade the Inside Day Candlestick?
When you locate an inside day candlestick on the daily chart, while there is a good and visible Bollinger Band breakout too (the way you learned above), you enter at the close of the inside day candlestick (which is the open of the next candlestick).
If formed on a bull market while hitting the Bollinger Upper Band, then you go short, set the stop loss several pips above the high price of the inside day candlestick, or preferably above the high price of the previous candlestick (the mother).
If formed on a bear market while hitting the Bollinger Lower Band, then you go long, set the stop loss several pips below the low price of the inside day candlestick, or preferably below the low price of the previous candlestick.
The target can be at least x2 or x3 of the initial stop loss size. If the inside day candlestick you locate is the beginning of a strong trend, then you can make up to x10 of your stop loss size.
Why Dose the Price Change Its Direction When the Inside Day Candlestick Forms?
What is the reasoning behind this? Before you read the answer I have given to this question below, think about the question and see if you can answer it.
I give you a clue: Candlesticks reflect the psychology of the markets (buyers and sellers).
When the price is going up strongly and several bullish candlesticks are formed, it means traders are buying and money is being injected to the market. All of a sudden, when a candlestick forms “inside” the high/low range of another candlestick, it means traders have stopped buying as strongly as they were used to buy during the previous days, and the money that was injected to the market was not enough to take the price higher than yesterday’s high. It means buyers have started changing their minds, and now they are thinking about selling what they had bought. And some of them have already started to sell. So the price will go down the next day after the inside day is formed.
It has the same reasoning for the cases that an inside day forms on a bear market.
This is very easy to understand, isn’t it?
Now, it is your turn to do your homework.
Locate the inside day candlestick on EUR/USD or other currency pairs daily charts. Consider the Bollinger Bands breakout too. See how you would trade those inside day patterns.
“Inside Day” candlestick is enough as the only trading system you choose. It forms on the currency pairs daily charts frequently enough for all of us to make money. To locate the inside day pattern, you only need to check the daily chart once per day when the new daily candlestick is opened. Have this pattern in your trading arsenal and enjoy the steady stream of profit.