Inside Bar.

Become a Master of One Technique

Filtering of Inside Bars

Copyright © 2016 by Maciej Goliński

Copyright © 2019 for English edition by Epilog

All rights reserved. This publication may not be reproduced using any available technologies, in any
form, in whole or in part without the consent of the copyright holder.

Published by Maklerska, Poznań, Poland

www.maklerska.pl

ISBN: 978-83-954505-0-1

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 Table of contents

Dedication
Introduction to Volume 2
How to read this book?

VOLUME 2. Filtering of Inside Bars

Chapter 6. Market Sector
Chapter 7. Market
Chapter 8. Time Frame
Chapter 9. Trend
Chapter 10. Relation of Open and Close of Bars Constituting an
Inside Bar Formation
Chapter 11. Consistency of a Breakout with the Direction of the
Close of the Last Bar
Chapter 12. Distance From Close of the Inside Bar to the Breakout
Level
Chapter 13. Relation of the Close of Bars Forming an IB
Chapter 14. Multiplicity of the Inside Bar
Chapter 15. Volatility
Chapter 16. Relation of the Size of the Inside Bar to the Mother Bar
Chapter 17. Day of the Week
Chapter 18. The General Context in which Inside Bar Formations
Emerge

Appendices
Footnotes
Other volumes of „Inside Bar”
 This book is dedicated to those dearest to me: Mikołaj, my son,
Łukasz, my exceptional brother, and my beloved parents, without
whom this work would never have been possible.
This is the second volume of the Inside Bar. Become a Master of One
Technique trilogy. Correct understanding of this book will be much
easier if you read the first volume of Inside bar. The Inside Bar
Effectiveness and Research Methodology.
In this book, I present specific filters that enable you to use the inside
bar pattern in practice. Each filter results from research based on 28,000
inside bar patterns and contains specific conclusions that you can use in
your own trading, and which I used to create examples of transaction
strategies described in the third volume. In this book I discuss the
following 13 filters:
– market sector
– market
– time frame
– trend
– relation of open and close of bars constituting an inside bar
formation
– consistency of a breakout in the direction of the closing of the last
bar
– distance from closing of the inside bar to the breakout level
– relation of the closing of bars forming an inside bar
– multiplicity of the inside bar
– volatility
– relation of the size of the inside bar to the mother bar
– effect of the day of the week
– the big picture in which inside bar formations emerge

I wish you a pleasant reading.

.

How to read this book?

This book is divided into three studies. First, I present the inside bar
formation (IB): its appearance, what makes it effective, and how to place
orders using it. In the second book, I focus on manners of selecting an
IB. I show how to filter IBs for better results. I present thirteen different
selection strategies and describe how to seek your own filters. The third
book explores the practical use of the formation: where to set stop-loss
and take-profit orders in open transactions using IB, how to assess the
reliability of specific formations, and descriptions of complete
investment strategies. Six strategies will be presented, one with a short-
term perspective, two medium-term and two long-term strategies, and
one mechanical approach. Almost every chapter contains empirical
studies I have conducted. Moreover, the entirety of the conclusions
presented here are the results of targeted analyses.
For those who are just beginning to learn IB, I advise reading through
the book at least three times. The first time is for acquiring basic
knowledge. Then, during the second reading, I recommend committing
the more important elements of the IB formation to memory, for the
rules governing its functioning and its general characteristics to become
clear. However, during the third reading, when studying specific
chapters, it is worth examining how well you have acquired the
presented knowledge by working with a chart. This will facilitate
effective and efficient mastery of the material in its entirety. Experienced
traders do not need to read the whole book; it is enough for them to
understand the first book while glancing over the rest of the material,
deciding which aspects of trading using IB are the most attractive for
themselves, and then focusing their attention on those elements. No
matter how advanced one is, it is vital to read the first book because my
perspective on IB may be a little different from the one readers are
familiar with, and this could make it significantly difficult to get a proper
understanding of later analyses.
I recommend to those who take a liking to trading using IB to spend
more time in order to understand it fully. Just reading through the book
one time and reviewing three graphs is not enough to safely and
consistently begin making money on the market using any method.
I spent over a year to get a thorough grasp on the IB formation myself.
I am sure that my readers will also need several months, even though
I have already done the analytical portion of the work for them. Keep in
mind that the hardest thing is to gain experience, because this requires
spending a lot of time on charts. That said, I am confident that it is worth
doing, because high-quality education about investing boosts your
chances of achieving long-term success in trading. Happy reading!
Maciej Goliński
 Volume 2
Filtering of Inside Bars

We have already learned from the previous book that IB gives us

a statistical advantage on the market. That said, we cannot forget that
every IB is different. Can we then answer the question of which IB
offers a bigger advantage over the others? Some elements present in an
IB enhance its effectiveness. Others, however, lead to the opposite effect,
making IB less attractive from the perspective of generating potential
profit. I refer the analysis of all these elements as filtering or selection.
In successive chapters we will explore the effectiveness of specific filters
such as:
– market sector
– market
– time frame
– trend
– relation of open and close of bars constituting an inside bar
formation
– consistency of a breakout in the direction of the closing of the last
bar
– distance from closing of the inside bar to the breakout level
– relation of the closing of bars forming an inside bar
– multiplicity of the inside bar
– volatility
– relation of the size of the inside bar to the mother bar
– effect of the day of the week
 – the big picture in which inside bar formations emerge

Analysis of certain filters is important as connecting them can

influence the effectiveness of systems based on IB. For example, if there
are two (or more) reinforcing elements in a given configuration
(e.g. a closing in the direction of a breakout, and concurrence of the
breakout with the trend on the market), this kind of signal would seem
more reliable than in the case of just one reinforcing element. The skill
to connect particular elements of IB, which gives a trader a real
advantage on the market, will be elaborated on in the third part of the
book where I present complete transaction strategies.
 Chapter 6
Market Sector

In this chapter we will perform an analysis of particular market sectors.

I have divided markets into the following groups (a detailed list of
instruments in particular groups can be found in Chapter 2):
Stock indexes. This group contains 15 instruments. Here we find all
of the leading indexes from both American and European markets.
I have also included in this group the futures contracts on the WIG20
and mWIG40[7].
Currencies. This group contains two types of instruments: futures
contracts and instruments from the Forex market. Keep in mind that the
same instrument (e.g. EUR/USD) noted in two places can differ slightly
from each other, which can have a significant impact on the
effectiveness of a given strategy or filter. This is why I have studied the
majority of basic currency pairs on both regulated and unregulated
markets. This group contains 21 instruments.
Metals. This group is relatively small, with only seven instruments,
but because of the popularity of commodities like gold, copper, and
silver, I have decided to discuss them separately.
Agricultural. This group contains 25 instruments. It encompasses
both grains and meat products. There are also such items as coffee,
cocoa, orange juice, and lumber.
Energy. This group contains six instruments, encompassing all of the
major fuels such as oil, natural gas, and gasoline. Some of them are on
multiple markets, such as oil, which is listed in both London and New
York.
Financial markets. The basic instruments here are all futures
contracts on American bonds. They are complimented by selected bonds
from the European market, as well as other, more advanced financial
instruments, such as swaps. This group includes 11 products.

STATISTICAL ANALYSIS

The opening of a transaction, as with every filter in this book, takes

place at the breakout of an inside bar, while the closing takes place in
accordance with the rules applicable to a given approach: short-term,
medium-term, or long-term[8].

Analysis of a short-term approach

Table 6.1. Analysis of particular market sectors – short-term approach

Market sector Percent of Total trades Profit Maximum Average trade Rate of return
winning drawdown
transactions
Agricultural 53.8% 8,556 $576,303 $-24,330 $67 2,369%
Stock indexes 52.7% 4,626 $264,160 $-47,353 $57 558%
Metals 52.1% 2,563 $324,455 $-74,123 $126 438%
Currencies 48.9% 7,776 $217,131 $-54,444 $28 399%
Energy 51.8% 1,879 $191,653 $-52,141 $102 368%
Financial 45.5% 3,258 $51,159 $-23,539 $16 217%
markets

Discussion of results:

1. All sectors generated a positive result. This is clear proof that the
transaction concept based on breakout from IB is stable and reliable.
Such a situation gives us the interesting possibility of constructing
a basket of instruments based on the best products in each sector. By
doing so, we can generate a list of the most effective but weakly-
correlated markets, which has a positive impact on portfolio
diversification.
2. If, however, we are looking at individual sectors, we may notice
that the results are quite diverse. By far the best result was achieved
by instruments from the agricultural category. In this sector the best
results are: percentage of profitable transactions, profit, and rate of
 return. This is no great surprise if we consider the fact that the
largest number of transactions was performed on agricultural
instruments. What can both surprise and encourage us to
concentrate on this very sector is the fact that with such a large
number of transactions conducted on strongly correlated markets,
the drawdown is only slightly larger than the lowest drawdown from
among all sectors (recorded on financial market instruments).
3. At the other end of our results are instruments from the financial
sector. The result they achieved is a positive one, but if we divide
the profit by the number of concluded transactions, we obtain an
average profit per position of $15.70. After deducting transaction
costs, this figure in real trading can potentially even lead to small
losses. Apart from the low profit on each transaction, this sector is
also distinguished by the lowest signal reliability.
4. The remaining four sectors, that is, stock indexes, currencies,
metals, and energy, generated comparable results. It is worth
observing, however, that the number of instruments in various
sectors is quite different. Although the smallest number of
instruments is to be found in the metals and energy sectors, the
results recorded by markets in that group are second- and third-best
in our table. This should lead to increased interest in these
instruments. It is much better to achieve a given result with the
smallest number of signals and greater expected value on each of
them. After all, every entry on the market entails exposure to risk.

Analysis of a medium-term approach

Table 6.2. Analysis of particular market sectors – medium-term approach

Market sector Percent of Total trades Profit Maximum Average trade Rate of return
winning drawdown
transactions
Energy 53.1% 1,212 $337,477 $-109,350 $278 309%
Agricultural 51.4% 5,329 $331,993 $-115,960 $62 286%
Metals 48.9% 1,609 $181,338 $-120,983 $113 150%
Currencies 49.0% 4,957 $84,629 $-197,225 $17 43%
Stock indexes 50.1% 3,129 $16,838 $-166,158 $5 10%
Financial 49.9% 1,998 $2,324 $-45,221 $1 5%
markets

Discussion of results:

1. The medium-term approach has generated poorer results in all

sectors in comparison to the short-term approach. Both the rate of
return and the size of drawdowns have worsened and the profit was
lower in five cases. Only the energy market recorded a higher profit
over the short-term approach. However, all of the sectors generated
a positive result again. This is important, as it confirms the stability
of the IB formation both in respect of the market on which it occurs
and the duration of a transaction.
2. The best results were generated by three sectors: metals,
agricultural, and energy. They are positively distinguished by their
rate of return. The worst of these three sectors was metals. It was the
only one among the medalists that did not reach a percent of
winning transactions level of 50%.
3. Spots 4, 5, and 6 were occupied by stock indexes, currencies, and
financial markets, respectively. Their rates of return oscillated
between 5% and 43%. This means in practice that after deducting
transaction costs, a trader on these markets would have difficulty
doing better than break-even. Average trade in those sectors was $5
for stock indexes, $17 for currencies, and $1 for financial markets.
I treat quite cautiously situations where the expected value is barely
enough to cover costs.

Analysis of a long-term approach

Table 6.3. Analysis of particular market sectors – long-term approach

Market sector Percent of Total trades Profit Maximum Average Rate of re-
winning drawdown trade turn
transactions
Agricultural 51.7% 3,646 $332,063 $-122,470 $91 271%
Energy 49.3% 877 $202,428 $-220,985 $231 92%
Stock indexes 52.5% 2,237 $79,690 $-95,470 $36 84%
Metals 51.6% 1,096 $128,605 $-244,173 $120 53%
Currencies 50.1% 3,409 $52,390 $-169,010 $15 31%
Financial markets 46.9% 1,368 $-101,563 $-137,561 $-74 -74%

Discussion of results:

1. Five of the sectors generated a positive result, while one (financial

markets) recorded a loss. The long-term approach is thus
characterized by the poorest results. When analyzing the declining
performance in successive tests as related to extended transaction
durations, we can confidently declare that the impact of IB on prices
weakens as more bars appear after the formation. This means that
IB performs best when capturing short price movements. It can be
applied using a long-term approach, but it should then be supported
using other tools such as ones which serve to indicate the direction
of a trend. I will say more about this in later chapters.
2. The most profitable sector is again agriculture, which recorded the
highest level of profit and highest rate of return (which confirms the
exceptionality of these instruments in the context of techniques
based on IB).
3. The weakest group was that of financial market, which generated
a loss of over $100,000. The rate of return over the examined period
was -74%.

RECOMMENDATIONS

1. I strongly recommend using instruments from the agricultural

markets sector in each of the approaches tested: short-, medium-,
and long-term.
2. When developing transaction strategies, markets worth your
attention are also instruments from the metals and fuels sectors.
Although they generated results which were lower than the
 agricultural sector, they did provide hope for satisfactory financial
benefits.
3. The stock indexes and currency markets generated results which
were close to the average for all sectors taken together. Thus, the
filter provided neither enhancement nor reduction of results.
4. I do not recommend using financial market instruments in any of
the approaches under discussion.
5. I also encourage you to build a portfolio based on the best
instruments from each sector, in both the short- and medium-term
approach. This will allow you to achieve diversification of the
markets used.
 Chapter 7
Market

Before we begin examining specific markets, I would like to draw

attention to one very important issue: if we focus on only one market,
the conclusions we draw will be based on a smaller statistical sample. As
a result, there is a greater risk of statistical error corrupting our results.
An analysis of sectors can be considered reliable, but we should
approach those based on specific markets with a certain amount of
caution.

STATISTICAL ANALYSIS

Because I have analyzed a very large number of markets, in the tables

below I present only the 15 markets which generated the highest rates of
return, and the five which generated the lowest. A list of all markets is
located at the end of the book.

Analysis of a short-term approach

Table 7.1. The 15 markets offering the highest rates of return – short-term approach
No. Market Percent of Total trades Profit Maximum Average Rate of
winning tran- drawdown trade return
sactions
1 Random 57.7% 338$40,964 $-2,860 $121 1,426%
Length
Lumber
2 Orange Juice 58.8% 452$37,673 $-2,835 $83 1,318%
3 Robusta 57.1% 366$21,890 $-2,230 $60 923%
Coffee
4 Chicago SRW 57.9% 375$42,838 $-4,813 $114 856%
Wheat
5 SAFEX soy 58.4% 322$58,830 $-8,535 $183 564%
6 US dollar / 52.9% 378$24,879 $-3,874 $66 564%
Brazilian real
 7 E-mini Dow 56.5% 308$23,325 $-4,135 $76 559%
8 Cocoa (CC) 57.6% 401$26,030 $-4,190 $65 541%
9 DJ Euro 54.3% 328$15,690 $-2,900 $48 499%
STOXX 50
Index
10 Soybean Oil 55.9% 356$18,510 $-3,612 $52 472%
11 KC HRW 56.5% 372$36,100 $-7,075 $97 424%
Wheat
12 Platinum 52.8% 375$43,205 $-10,270 $115 418%
13 Cocoa (LCC) 49.1% 375$8,420 $-1,750 $22 410%
14 RBOB 55.4% 303$78,229 $-18,379 $258 392%
Gasoline
15 Russell 1000 59.4% 180$23,975 $-5,405 $133 386%
INDEX MINI

Discussion of results:

1. Five of the top markets are instruments from the agricultural sector.
They are: lumber, orange juice, Robusta coffee, wheat, and soy.
Each of these markets generated over 300 transactions in the course
of 10 years. This gives us an average of over 30 transactions per
year, statistically at least one transaction every two weeks. The
frequency of IB formations on particular markets is important for
developing concrete transaction strategies, and in the context of an
individual trader’s preferences. For example, a strategy that
generates one signal every two weeks can, for an active trader, be
exceptionally frustrating.
2. The best markets achieved an accuracy rate of 57% or higher,
which provides us with a good basis for generating systematic and
stable profits. It should, however, be pointed out that every value for
the parameter in the set presented above is attractive. Even the
cocoa (LCC) market, which achieved the lowest accuracy (only
49.1%, an 8% difference from the market with the highest
accuracy), generated good results. Accuracy is, of course, not the
only factor impacting the expected value of a given signal, but it is
quite significant, and a trader should be aware that a change in
accuracy of a few percentage points can impact the final result. For
 example, the “0” field in roulette gives the casino only a 3%
advantage over their client, but this is enough for the casino to
achieve spectacular profits.
Let us imagine that a trader is operating with accuracy at a level of
40%, while his losses are 10 pips, and profit is twice as much, at 20
pips. A strategy operating under these assumptions generates an
expected value per transaction of two pips (0.4 x 20 pips – 0.6 x 10
pips = 2 pips). However, if this trader could improve accuracy by
just 3.4% and maintain the remaining parameters of his system,
results would be greatly improved. How much? It is enough to do
calculations based on the template used in the previous sentence
(0.434 x 20 pips – 0.566 x 10 pips = 3.02 pips), and it turns out that
the expected value per transaction increases by 50% - from two to
three pips. You could say that is not much, but for a day trader who
enters into a large amount of transactions, a small increase in
accuracy can lead to drastic improvements in the overall results!
In my trading I always put quality over quantity, which is why
I frequently prefer a reduced number of transactions in exchange for
improving their accuracy.
3. The rate of return of the best markets ranges from a few hundred to
as much as 1,426%. However, it should be pointed out that this
statistic assumes the simplest capital management: each transaction
is opened using one contract. If a slightly more aggressive approach
towards managing risk is applied, results would certainly improve.
4. The first three markets in the table should be given special
attention, as their drawdowns are low (not exceeding $3,000),
which, in comparison to the profit, looks quite promising indeed.
The trader should always analyze the results of a strategy through
the lens of drawdown. It is far better to earn a given sum of X with
a drawdown of 10% of X compared to, say, 50% of X. Also, if we
approach drawdown from the perspective of a concrete sum of
money, it can turn out that the trader would be unable to survive
 a period of worse performance by the trading strategy. For example,
a loss of $4,000 for a trader with a balance of $5,000 makes him
essentially bankrupt, but an investor with capital of $20,000 can
accept that kind of drawdown.

Table 7.2. Five markets with the lowest rate of return – short-term approach
No. Market Percent of Total trades Profit Maximum Average Rate of
winning drawdown trade return
transactions
1 Three month 26.6% 515$-3,150 $-3,150 $-6 -99%
Euribor
2 NZ dollar / US 43.7% 339$-12,597 $-13,399 $-37 -93%
dollar
3 US dollar / 42.5% 365$-10,962 $-14,264 $-30 -76%
Canadian
dollar
4 Euro / US 46.0% 324$-14,438 $-19,691 $-45 -73%
dollar
5 2-YEAR T- 40.2% 333$-2,938 $-3,984 $-9 -73%
Note

Discussion of results:

1. Three of the five worst performers are currency markets

(NZD/CAD, EUR/USD, USD/CAD), and two are from the financial
instruments sector (3-month futures on EURIBOR and 2-year USA
treasury bonds). Each instrument in the table presents an
effectiveness below 46% (3-month EURIBOR only 26.6%!), which,
when taking the results of the best markets into account
(significantly above 50%) along with the casino sample, means that
the results of those instruments are, to put it mildly, poor.
2. Rates of return oscillate within a range of -73% to -99%. This
shows us that on these markets we are consistently losing money –
the value of the drawdown is close to the profit. In other words, our
equity curve is continually falling.
3. I avoid markets which deliver results similar to the ones presented
above. I also recommend that you apply special caution with these
instruments! I would also like to add here that markets where results
 oscillate around the break-even point are, in my view, not worth
your consideration.

Analysis of a medium-term approach

Table 7.3. The 15 markets offering the highest rates of return – medium-term approach

No. Market Percent of Total tradesProfit Maximum Average Rate of

winning tran- drawdown trade return
sactions
1 Orange Juice 55.0% 260$41,970 $-8,745 $161 423%
2 RBOB 58.7% 201$159,617 $-41,798 $794 353%
Gasoline
3 CBOE 52.2% 207$63,150 $-15,800 $305 333%
Volatility
Index
4 Robusta 56.3% 238$25,260 $-7,690 $106 308%
Coffee
5 Japanese yen 54.4% 252$51,325 $-18,138 $204 283%
/ US dollar
6 Palladium 52.2% 232$50,505 $-17,295 $218 280%
7 Ethanol 58.3% 175$55,825 $-19,923 $319 261%
8 US dollar / 54.1% 259$30,486 $-12,295 $118 239%
Japanese yen
9 WIG20 Index 67.4% 43$13,120 $-3,600 $305 239%
10 Brent Crude 52.6% 209$60,260 $-26,460 $288 211%
11 SAFEX soy 52.2% 201$57,600 $-26,150 $287 210%
12 Cotton No. 2 47.3% 237$29,650 $-13,850 $125 188%
13 Pork Bellies 62.6% 107$28,890 $-15,470 $270 164%
14 Canadian 55.5% 209$32,253 $-19,348 $154 153%
dollar /
Japanese Yen
15 Coffee C 50.8% 242$50,438 $-32,513 $208 151%

Discussion of results:

1. The five best instruments from the medium-term perspective are

more diverse in terms of sector than markets in the short-term
approach. Four sectors are represented in the table above. Markets
whose percent of winning transactions oscillates between 54.4% and
 58.7%, and with rates of return from 283% to 424%, are: orange
juice, gasoline, volatility index, Robusta coffee, and JPY/USD.
2. In general, results from the medium-term approach are worse than
short-term results. The average rate of return on the 15 best markets
in the latter amounts to 751%, whereas in the former it is 260%.
This situation results from the fact that IB is a formation whose
impact is greatest immediately following the breakout of the inside
bar. The more bars after that breakout, the lesser the predictive value
of the formation. In drawing these conclusions, we could ask
ourselves the question of why we should bother using IB in
a medium- or long-term approach. Would it not be better to focus on
the formation in only short time frames? As I mentioned before,
I am a believer in adapting trading to the trader’s personality, not the
trader’s personality to trading. An investor will achieve much better
results when he is confident in using a given method as opposed to
using any other method (even the best) without internal support.
This is why, if my investment preferences corresponded with the
medium-term approach, I would be fine with looking for
reinforcement from IB in that time frame. In the third part of the
book I will present effective strategies for holding a position over
a period of longer than one session.
3. We should also pay attention to drawdowns, which are much higher
in comparison to the short-term approach (average value of $20,370
compared to $5,737). Generally, we should adopt the rule that the
longer (in the context of a transaction’s duration) a trader is on the
market, the greater the exposure to large drawdown. This is why we
should always know the answer to the question of whether holding
a position at a given moment is justified in light of strategy, or
perhaps is the result of some other motivation.
4. An interesting thing is the presence of the WIG20 among the 15
best instruments. The accuracy of the Warsaw index was 67.4%.
The inquisitive among us should most certainly look this market
 over, but I personally am quite cautious when it comes to such
incredible results. While I am confident in data from the American
market, I do not have absolute certainty as to the quality of listings
of futures contracts on the WIG20 supplied to the Trade Navigator
platform.

Table 7.4. Five markets with the lowest rates of return – medium-term approach
No. Market Percent of Total trades Profit Maximum Average Rate of
winning tran- drawdown trade return
sactions
1 Euro / Swiss 37.5% 232$-63,076 $-63,632 $-272 -98%
franc
2 E-mini Dow 41.9% 203$-30,790 $-32,415 $-152 -94%
3 British pound 46.7% 214$-50,460 $-55,730 $-236 -90%
/ US dollar
4 Copper 44.2% 224$-63,663 $-70,875 $-284 -89%
5 Oats 42.5% 252$-24,050 $-27,588 $-95 -85%

Discussion of results:

1. The profit for each of the markets presented above is negative, and
the rates of return are close to the drawdown value. If applied to
these instruments, IB would most likely generate consistent losses.
Experienced traders might even let themselves be tempted to create
a strategy consisting in taking positions against an IB breakout.
2. In the above group, the weakest markets were: EUR/CHF, Dow
Jones, GBP/USD, copper and oats; two currency markets, one stock
index, one metal, and one agricultural commodity. Based on my
own experience, I can say that IB does not perform optimally on
large and liquid markets (Dow Jones, selected currency markets),
where breakouts are frequently faded, and therefore end in failure.

Analysis of a long-term approach

Table 7.5. The 15 markets offering the highest rates of return – long-term approach
No. Market Percent of Total trades Profit Maximum Average Rate of
winning tran- drawdown trade return
 sactions
1 Orange Juice 55.3% 170 $50,843 $-6,473 $299 639%
2 Russell 1000 59.6% 94 $35,385 $-8,170 $376 295%
INDEX MINI
3 FTSE-100 54.7% 139 $34,050 $-13,180 $245 254%
Index
4 US dollar / 57.8% 166 $42,707 $-16,369 $257 250%
Japanese yen
5 US dollar / 54.0% 161 $30,141 $-11,266 $187 250%
Brazilian real
6 Robusta 51.6% 155 $17,660 $-7,460 $114 236%
Coffee
7 Soy 54.3% 151 $55,450 $-25,625 $367 208%
8 Feeder Cattle 56.7% 150 $37,863 $-17,675 $252 202%
0 Soybean Oil 53.3% 152 $22,710 $-10,638 $149 199%
10 SAFEX soy 53.5% 144 $45,935 $-23,040 $319 193%
11 Ethanol 48.4% 124 $54,462 $-26,883 $439 186%
12 Soybean 52.6% 154 $32,540 $-16,680 $211 183%
Meal
13 Swiss franc / 51.0% 151 $23,789 $-11,729 $158 176%
Japanese Yen
14 RBOB 54.4% 147 $119,078 $-71,362 $810 160%
Gasoline
15 Euro / US 52.3% 153 $41,450 $-28,663 $271 122%
dollar

Discussion of results:

1. The rates of return from the long-term approach (average: 254%)

are near those generated by the medium-term approach (average:
260%). This results from the fact that, from the perspective of profit
expressed as a percentage, the choice of transaction duration among
the best markets is not of any great significance. Individual
investor’s preferences should take precedence in such cases.
2. Among the five best markets, we should definitely pay attention to
the very high percent of winning transactions, fluctuating between
54.7% and 59.6%. This figure is exceptionally encouraging,
particularly considering that IB is a breakout strategy.
3. Among the most effective markets there were: orange juice, E-mini
Russell 1000 index, FTSE 100, USD/JPY and BRL/USD. Here
 I would like to draw your attention to the difference that exists
between markets. For example, earlier I wrote that breakout
strategies do not function well on stock indexes. Yet here, two of the
five best performers were instruments based on indexes. Not all
indexes are equal. Russell is most certainly correlated with the S&P
500, but the price movement mechanisms on the two markets are
different. Pullbacks and false breakouts on the index of the 500
largest American companies will most certainly come more
frequently than on a less liquid market, which will always move
more decisively in a given direction.
4. I would also like to draw attention to the fact that the TOP 5
contains markets representing three sectors (agricultural, stock
indexes, currency). I view this as a beneficial situation, because
instruments from diverse groups demonstrate a smaller correlation
factor, which makes drawdowns for a strategy on a given group of
markets shallower and shorter in duration.

Table 7.6. Five markets with the lowest rates of return – long-term approach
No. Market Percent of Total trades Profit Maximum Average Rate of
winning tran- drawdown trade return
sactions
1 Euro / Swiss 40.1% 157$-63,086 $-67,329 $-402 -93%
franc
2 US dollar / 40.6% 165$-56,370 $-63,395 $-342 -87%
Swiss Franc
3 U.S. Treasury 41.5% 159$-55,984 $-68,359 $-352 -80%
Bond
4 E-Mini 48.0% 148$-46,320 $-57,405 $-313 -80%
NASDAQ 100
Index
5 Oats 48.2% 168$-16,488 $-21,075 $-98 -73%

Discussion of results:

1. Among the five weakest performers are two currency markets

(EUR/CHF and USD/CHF), one stock index (E-mini NASDAQ
100), a financial market (30-year bonds), and an agricultural
 commodity (oats). Comparing the profit to maximum drawdown,
we can say that these markets consistently lost money.
2. As we discuss results, it is worth drawing attention to the low
percent of winning transactions. The market with the lowest rate of
return (EUR/CHF) recorded accuracy of 40.1%, which, when
compared to the best market in the long-term approach (orange
juice; 55.3%), indicates a significant disproportion. If casinos are
capable of achieving incredible results with just a 3% advantage,
what can a trader do applying a strategy that on particular markets
demonstrates deviation of over 10%? Thus, selection of the right
market to trade on is of key importance.

RECOMMENDATIONS:

1. I am a strong advocate of trading on the markets which were in the

top 15 in each of the analyzed approaches: orange juice, Robusta
coffee, gasoline, and soybean (SOY). The reliability of these
instruments is greater, and it is more likely that specific strategies
for this group of products will demonstrate greater stability over the
long-term. Remember that our primary objective is not to maximize
profits, but rather to optimize profits while taking into consideration
the level of risk acceptable to a given trader.
2. It is also worth taking an interest in markets which appeared twice
in the tables above, that is USD/JPY, USD/BRL, soybean oil, and
ethanol.
3. I would suggest greater caution on the following markets:
EUR/CHF, USD/CHF, NZD/CAD, EUR/GBP, GBP/USD, 30-years
US treasury bonds, 3-month EURIBOR, 2-year US treasury bonds,
E-mini NASDAQ 100, E-mini Dow, E-mini S&P 500, oats, and
copper.
4. A very specific indication of the strongest and the weakest markets
need not always be associated with narrowing the range of
instruments we can take on (through focusing on the most profitable
 products or not concluding transactions on the weaker ones). This
approach can, of course, be analyzed, but the information presented
in this chapter may also be used in a different manner. For example,
it frequently occurs that a slowdown takes place on multiple
markets at the same time. Let us imagine a situation where on
a given day we have around 10 IBs. There is no sense in acting on
all signals, so in these situations we have to choose the pattern
(perhaps two or three) which we feel will give us the greatest
chances for success. And this is why we need to use analyses of
individual markets, to help us choose the instruments which will
generate better results in the future.

In the Appendices you will find a complete list of markets.

 Chapter 8
Time Frame

All of the tests conducted in the preceding chapter were done in the daily
time frame. However, not all traders trade in that perspective. For that
reason, in this chapter, we will review the effectiveness of IB in such
perspectives as m30, m60, h4, daily, weekly, and monthly. As in
previous chapters, the tests have been conducted on 82 markets; intraday
data has been analyzed for a period of three years (owing to limitations
in the available data), while for the greater time frames I have examined
the last 10 years.

STATISTICAL ANALYSIS

Analysis of a short-term approach

Table 8.1. Effectiveness of IB in particular time frames – short-term approach

Time frame Percent of Total trades Profit Maximum Average Rate of re-
winning drawdown trade turn
transactions
Monthly 51.6% 1,046 $160,378 $-1,056,260 $153 15%
Weekly 52.7% 4,673 $617,503 $-108,305 $132 570%
Daily 51.1% 28,647 $1,624,860 $-62,090 $57 2,617%
h4 44.5% 62,052 $-168,359 $-222,991 $-3 -76%
h1 40.6% 214,264 $-247,772 $-349,089 $-1 -71%
m30 38.7% 430,825 $-576,751 $-679,961 $-1 -85%

Discussion of results:

1. In analyzing the data set we may assume that the higher the time
frame, the more reliable the indications generated by IB. This
concerns not only the formation we are examining presently, but
price action formations in general. I do not have any other evidence
 in support of this conclusion (of course, with the exception of the
analyzed table), but I am strongly convinced as to the existence of
such a rule. Experience has taught me that the greater the time
frame, the more investors treat such a formation as reliable.
2. The best results were clearly achieved by the daily time frame
(profit: $1,624,860; rate of return 2,617%), followed by weekly and
monthly. It should be observed, however, that this classification is
according to rate of return. If we took into consideration average
trade, the effect would be just the reverse: monthly $153, weekly
$132, daily $57.
This very good average trade for the highest frames should,
however, be accompanied by a restrained optimism. Indeed, the
value of the drawdown should be noted, which in the case of
monthly data amounted to more than $1 mln (this drawdown with
1,046 transactions and a quite positive profit of $160,378 offers only
a 15% rate of return). Such a high drawdown rate results from large
stop-losses (recall that we are employing stop-loss based on time),
which occur in larger time frames.
3. It is important to pay attention to number of total trades. In the last
ten years, a total of 1046 signals were generated at the monthly
charts, while as many as 28,647 came at the daily time frame. This
larger number of IB formations, even when accounting for the
weaker average trade result compared to the monthly time frame
($57 versus $153) allowed us to generate ten times the profit ($1.6
mln versus $160,000). In analyzing results, we should always be
aware of all of the factors affecting the final result.
4. What may come as a surprise to some is the clearly poorer results of
IB at lower time frames. At the h4, h1, and m30 charts, rates of
return were negative and oscillated at a level of between -71% and
-85%.

Analysis of a medium-term approach

Table 8.2. Effectiveness of IB in particular time frames – medium-term approach
Time frame Percent of Total trades Profit Maximum Average Rate of re-
winning drawdown trade turn
transactions
Monthly 50.5% 717 $-14,249 $-373,051 $-20 -4%
Weekly 51.8% 3,213 $166,913 $-702,522 $52 24%
Daily 50.3% 18,234 $954,598 $-336,251 $52 284%
h4 48.3% 36,088 $273,064 $-140,012 $8 195%
h1 46.0% 121,674 $-327,662 $-361,140 $-3 -91%
m30 44.6% 238,209 $-757,268 $-827,470 $-3 -92%

Discussion of results:

1. The best rate of return was again achieved by the daily time frame
(284% with a similar average trade of $52), yet with a significant
rise in drawdown ($336,251 versus $62,090). On the one hand, this
result confirms the stability of the time frame in the context of IB,
while on the other it shows us that IB is a formation that works best
in the “here and now”. In other words, we are trading on the basis of
a specific formation, expecting a dynamic breakout, and after it
occurs we take our profit relatively quickly.
2. Second place was taken by a somewhat swashbuckling time frame
h4. I am unable to explain this result. Perhaps it could be the effect
of the markets’ somewhat random nature. It should be kept in mind
that the markets do adhere to certain rules, but nevertheless price
remains determined to a large degree by factors which are difficult
to identify. Because the h4 time frame appears high in our rankings
only in the medium-term, I would suggest analyzing it more closely
before putting it into practice.
3. The weekly time frame completed the reviewed period with a slight
profit (high drawdown of over $700,000 reduced the rate of return
to 24%), while the monthly perspective was roughly break-even.
The lowest time frames, h1 and m30, again demonstrated their
weakness in the context of IB.

Analysis of a long-term approach

Table 8.3 Effectiveness of IB in particular time frames – long-term approach
Time frame Percent of Total trades Profit Maximum Average Rate of re-
winning drawdown trade turn
transactions
Monthly 55.4% 513 $570,648 $-591,138 $1,112 97%
Weekly 51.1% 2,304 $387,554 $-474,782 $168 82%
Daily 50.7% 12,633 $693,613 $-264,349 $55 262%
h4 48.7% 22,929 $-2,544 $-272,184 $0 -1%
h1 47.4% 79,403 $-89,660 $-273,862 $-1 -33%
m30 46.6% 155,010 $-419,982 $-480,221 $-3 -88%

Discussion of results:

1. At first glance we can see that the rate of return in the long-term
approach does not differ significantly from that of the medium-term
approach. The best performer was the daily time frame (again
confirming the stability of this perspective within the context of IB),
which over a period of 10 years generated a profit of almost
$700,000, with a rate of return of 262% and average trade of $55.
2. The two remaining time frames, weekly and monthly, also
generated significant profit. Rates of return oscillated around 100%,
at 82% and 97%, respectively. Particularly worthy of note is the
value of the average trade generated in the monthly data - $1,112 is
a per-transaction profit around 7 times greater than weekly IBs, and
20 times greater than daily IBs. Unfortunately, we are still dealing
with one of the greatest weaknesses of the largest time frame, that
is, drawdown, which exceeds $590,000. This drawdown is in
practice unacceptable to the majority of individual investors.
3. The h4 time frame, which had previously surprised us with its
positive result, is now hovering around the zero mark. The two other
intraday time frames are consistently recording results much below
the break-even level.

RECOMMENDATIONS:
1. I strongly recommend applying IB on the daily charts. This solution
is the best compromise in the context of profits and the drawdown
we observe. In each of the three approaches, this time frame is
among the best performers. This attests to the stability (average
trade value consistently oscillated between $52 and $57) and the
reliability of IB on charts with the most popular time frame.
2. It is worth considering the use of IB on the weekly charts as well.
Profits in this time frame were stable and satisfactory, although
a clear disadvantage is the need to apply large stop-losses, which
can lead to significant drawdowns. How can a trader attempt to
reduce drawdowns? By introducing tighter stop-losses into the
strategy, or by adding more of the filters I will describe in the next
chapters. It should be kept in mind, however, that every
modification of a strategy requires additional research.
3. Although profits in the monthly time frame of two out of three
approaches were satisfactory, which I would interpret as a certain
regularity of results, the massive drawdowns would seem to be
a large problem. One solution could be ETFs or other instruments
offering lower exposure to risk than contracts. The specificity of
those markets is, however, entirely different, and the research
presented in this book should not be applied to other instruments
than those I have used in analyses.
4. From the perspective of the conducted tests, I would draw attention
to the necessity of being cautious when applying IB to the intraday
time frames: h4, h1, and m30. I would, however, like to point out
that this does not mean the total exclusion of those time horizons
from our trading. I myself am a day trader, and I use IB formations
even at the m5 charts. When I say “be cautious”, what I mean is that
a trader going to the lower intervals must be aware of the reduced
effectiveness of IB; this means that the filters reinforcing particular
signals should be stronger than, say, on the daily chart.
 Chapter 9
Trend

In this chapter we will examine how the effectiveness of IB is influenced

by the presence of a trend. However, before we review our tests, there are
several important issues we need to discuss. First and foremost, I would
like to emphasize that there is no ideal method for identifying trends.
While there are many tools described in books and on the internet, which
are more or less similar to one another, the truth is that we should not allow
ourselves to be fooled into believing we will find a method guaranteeing
a 100% success rate. No such method exists, and attempts to find
perfection are merely a waste of time. As I have already mentioned, every
method can be adapted to a given period on a chart, but we must remember
that the market is a collection of investors, a living organism, which does
not like to maintain the status quo. The market is dynamic, and something
which today provides us with spectacular results may tomorrow turn out to
be worthless. This is why the best solution is to apply simple tools in our
trading which may not offer spectacular results, but will stand the test of
time.
Every method performs better or worse depending on the situation.
Experience has taught me to not be bothered by this fact. Today, after 20
years of trading, I think that the majority of methods offer similar levels of
effectiveness. In spite of their similarities, there is a certain important
element distinguishing them: sensitivity. Generally, we can assume that
more sensitive methods will identify a trend quicker, and they will offer
more signals of trend changes (including false signals), while less sensitive
methods will generate those signals less frequently and at later stages of
a movement, but with greater predictive accuracy. This is the foundation,
the idea on which I base my trading. I personally prefer the latter approach,
meaning I can accept a smaller number of signals from the method applied
in exchange for reductions in profit coupled with greater reliability. When
discussing the method of the trend applied in the following test, I will
again return to the issue of sensitivity and use a concrete example to
illustrate the concept.

DISCUSSION OF THE TREND IDENTIFICATION METHOD APPLIED IN THE

RESEARCH

In order to ensure that the test conducted would be as understandable as

possible, I have selected one of the simpler methods for trend
identification. When I say “simpler”, I do not mean “worse”; I successfully
use the presented tool in my own trading. That said, I would like to
emphasize that this tool may not be the right answer for everyone, so those
of you with enough time and determination should seek your own methods
for identifying trends that better suit your style and personality.
To identify trends I will employ the moving average method. When the
moving average is below the current price, this means that the market is
uptrending. However, if the moving average is above the current price, this
means that investors in a bear-like mood are exerting the most influence. In
Diagram 9.1
Diagram 9.1. Identifying a trend using moving average
Diagram 9.2. Opening a transaction in accordance with the direction of a trend

I have placed a price chart on which an uptrend and downtrend are marked,
as well as changes in the trend.
The trend thus identified will determine the direction in which
transactions will be concluded. By the same token, during a bull market we
will be seeking to trade only on upside breakouts of IB, while during a bear
market – only on downside breakouts. This concept is presented in
Diagram 9.2. In the chart being analyzed we can see that the uptrend
begins with the eighth bar from the left side. After several bars of uptrend,
the first IB formation emerges. The breakout from this formation is
upward, so in accordance with the assumptions I have already detailed,
a transaction should be opened. After a few more bars, IB no. 2 emerges.
In this case, however, we see that the market is still going up, while the
breakout is downward. In these situations, we will not open a transaction.
The method I have described has its obvious drawbacks, but also some
advantages. Diagram 9.3. contains an elaboration of the three most
important characteristics of the moving average as a tool for identifying
a trend.
The flaw in the moving average is its poor performance in sideways
trends. While it is the case that no method performs well when the market
is moving horizontally, there are methods which allow us to avoid false
entries with a certain degree of certainty. The moving average in the
consolidation, however, consistently points to a change in buy and sell
signals, which means that our capital can be reduced by a series of losing
transactions. It should be noticed, however, that this flaw can be overcome
by adding the appropriate criterion (e.g. taking signals only on
corrections). I do not want to go deeper into this issue as it would divert
our attention from the subject at hand, so let us just accept this
imperfection and move on to the next characteristic.
Diagram 9.3. Characteristics of the moving average as a method for identifying a trend

In my trading, I use moving averages created strictly with the use of

large parameters (e.g. 250). I keep my distance from derivatives created
using smaller numbers of periods, like 10 or 20. Large parameters allow
me to remain in a developing trend longer (corrections do not toss me out
of the market). This, of course, has its price: both the beginning and ending
signal of a given market tendency are generated late, which means I miss
out on part of the movement. But as we know, there is no ideal solution
when it comes to trading!
In the test whose results I have given on the following pages, I have
employed the moving average, but with three degrees of sensitivity. The
first average was created using 100 periods; the second with 150; and the
third with 200. The differences between them are depicted in the chart in
Diagram 9.4.
 The diagram displays the beginning and the ending of the trend within
the context of a significant downward movement with the application of
various parameters. The 100-period moving average shows the start of
a new trend earlier than others, while the 200-period average identifies it
the latest. Some investors view the late signal of a trend as a flaw. When
adopting this stance, we should take into consideration the other side of the
coin. Specifically, if we look at a signal indicating the end of a trend, we
will clearly see that the 200-period moving average gives us the potential
to maintain a profitable position for the longest period of time, whereas
a shorter average – 150- and 200-period – would get us stopped out from
the market earlier, generating false pro-uptrend signals.

Diagram 9.4. Comparison of moving average for 100, 150, and 200 periods

While discussing this chart, I would like to draw your attention to one
particular issue. As we observe serving the 150-period moving average, we
may get the impression that at the second local high in the correction it
perfectly functioned as resistance. Can we therefore claim that, in the case
of this instrument moving average, it has some magic powers? Not at all!
Please believe me that this is nothing but a mere coincidence. I have
analyzed hundreds of charts over many years, and I have never
successfully identified an iron law in the context of moving averages and
their parameters that could be applied across multiple markets for a longer
time period. The strength of the moving average lies not in the parameter,
but in consistently following the trend.

STATISTICAL ANALYSIS

Analysis of a short-term approach

Table 9.1. Impact of trend presence on IB effectiveness – short-term approach

Trend identification method Percent of Total trades Profit Maximum Average Rate of re-
winning drawdown trade turn
transactions
All IB 51.1% 28,647 $1,624,860 $-62,090 $57 2,617%
SMA 200 51.5% 17,271 $864,865 $-81,686 $50 1,059%
SMA 150 51.6% 17,260 $848,205 $-105,914 $49 801%
SMA 100 51.7% 17,227 $767,869 $-96,750 $45 794%

Discussion of results:

1. All of the tests generated results significantly worse than those of the
unfiltered IB. The percent of winning transactions, however, did not
decline, oscillating within a range of 51.5%-51.7%; this is only
slightly higher than the test in which trend identification tools were
not applied (51.1%). The average trade was somewhat decreased, but
not enough to significantly damage the profit and rate of return. It was
primarily the effect of a reduction in the number of transactions that
led to the decline in results. Let us keep in mind that the trend filter
eliminates those breakouts which did not follow the dominant trend[9].
To summarize: when discussing the short-term approach, we do not
 apply a filter, as it rejects both good and bad transactions at the same
rate.

Analysis of a medium-term approach

Table 9.2. Impact of trend presence on IB effectiveness – medium-term approach

Trend identification method Percent of Total trades Profit Maximum Average Rate of re-
winning drawdown trade turn
transactions
All IB 50.3% 18,234 $954,598 $-336,251 $52 284%
SMA 150 52.0% 12,859 $1,283,863 $-295,873 $100 434%
SMA 100 51.6% 12,867 $1,185,013 $-282,090 $92 420%
SMA 200 51.8% 12,865 $1,115,288 $-270,887 $87 412%

Discussion of results:

1. Each of the tests conducted generated significantly better results than

in the case of the IB unlimited by any filter. The nearly doubled
average trade is clear proof that applying moving averages is
appropriate, but only in conjunction with an extended transaction
duration. The test was conducted for a period of five days, but perhaps
the filter would also work for a period of three or four days. The ideal
parameter depends on many different factors (e.g. the specific
market), but there is no sense in looking for it because it is
changeable. In this conclusion, therefore, I am postulating a certain
dependence resulting from the application of a trend filter and the time
horizon adopted for a given transaction.
2. The results of the different moving averages are similar. Therefore we
can see that the degree of sensitivity characterizing the trend method
adopted in the tests does not significantly impact the results achieved.

Analysis of a long-term approach

Table 9.3. Impact of trend presence on IB effectiveness – long-term approach

Trend identification method Percent of Total trades Profit Maximum Average Rate of re-
winning drawdown trade turn
transactions
All IB 50.7% 12,633 $693,613 $-264,349 $55 262%
SMA 150 52.7% 9,741 $2,051,322 $-315,998 $211 649%
SMA 100 52.2% 9,781 $1,747,360 $-314,804 $179 555%
SMA 200 52.4% 9,724 $1,691,075 $-314,771 $174 537%

Discussion of results:

1. All of the tests generated better results than unfiltered IB (rate of

return: 262%) and IB with the filter in the medium-term approach
(average rate of return from the three approaches: 422%). This is
a strong confirmation of the potential offered by the tool under
consideration here.
IB is a formation that offers the greatest benefits in a short time
horizon (as expressed in bars). The more time that elapses from the
emergence of the formation, the larger the decline will be in its
predictive value. This does not change the fact that it can also be used
in long-term transactions. Keep in mind that IB represents a certain
confusion in the market. For example, if a confusion occurs at the
bottom of a correction, this can be the start of a strong trending
movement, and the IB formation can serve as an opportunity to join
the trend. The condition: a breakout in the right direction. Trend
identification methods are for precisely the task of determining the
direction of a breakout.
2. The application of a filter in the long-term approach also improved
the percent of winning transactions. That said, the improvement is not
significant, and there is no sense in employing a trend identification
tool for this sole purpose. The most important parameter that should
be observed is the average trade, which shot up to an unimaginable
degree (short-term approach: $48, medium-term: $93, long-term:
$188). Improvement in this parameter confirms the power of the
trend: opening a transaction in line with the dominant trend on the
market and for the appropriate length of time to allow profits to
develop is one of the keys to effective trading.
3. The trend filter rejected around 1,800 transactions, by the same token
reducing their number from the initial 9,700 to around 7,900. Despite
 the lower number of signals, the profit improved three-fold. The trend
is a trader’s powerful ally.
4. I would also like to emphasize again that there is nothing magical in
the number 10. The fact that we close the transactions after this length
of time results exclusively as a result of the assumptions adopted. It is
possible that similar or better results (or worse ones as well, but I have
not checked) can be achieved by applying a parameter such as 8, 9,
11, 15, or something else.

RECOMMENDATIONS:

1. I strongly recommend applying a trend identification tool with a long-

term strategy. Improving results coupled with extended transaction
durations confirm the stability of the examined filter. In terms of long-
term transactions, a trend filter is essential.
2. It is worth considering the use of a trend filter in conjunction with
a medium-term approach.
3. In my career I have devoted significant time to analyzing particular
methods of trend identification. After a time, I reached the conclusion
that the best methods are the simplest ones, and thus the most stable.
I have conducted all of the tests in this chapter using moving averages.
Let us remember, however, that in selecting the parameter of the
moving average on whose basis it will be established, we should be
ready to accept some imperfections. The best move is to decide on one
value for the parameter and to apply it consistently for a long time. It
should be observed that the results for the parameters of 100, 150, and
200 were always much better than those in the absence of a filter (with
the exception of the short-term strategy).
4. There is no sense in using a trend filter for the short-term strategy.
A tool for identifying the dominant tendency on the market will not
improve the effectiveness of signals, nor the size of the profit (because
of insufficient time to make a move) generated by a transaction which
is closed after one day. Other filters should be used to improve IB
results in short time strategies.
 Chapter 10
Relation of Open and Close of Bars
Constituting an Inside Bar Formation

In this and the next three chapters I will engage in an analysis of the shape
of the IB formation. I will first demonstrate how the relation of open and
close prices in specific bars impacts the effectiveness of the formation.
Below I will present four versions of IB to be analyzed.

INTERIOR TYPE OF IB FORMATION

The interior type of formation occurs when the open and close prices of the
inside bar are located between the open and close prices of the mother bar.
In Diagram 10.1 I present four possible versions fulfilling these criteria.

Diagram 10.1. Interior type of formation

What led me to test this variant of IB were the numerous examples of

texts I have encountered in which the IB formation is delineated on the
basis of the open and close prices of specific bars, and not on the basis of
their extremes (that is, the method we have adopted for our book). Because
I have the natural curiosity of a researcher, I decided to check and see if
this approach is, in fact, justified.
EXTERIOR TYPE OF IB FORMATION

The second group we will test is a formation in which the open and close
prices of the inside bar encompass the open and close prices of the mother
bar. Diagram 10.2 displays four variants of such a situation.

Diagram 10.2. Exterior type of formation

UPTREND TYPE OF IB FORMATION

An uptrend IB formation appears when the open and close prices of the
inside bar are located higher than the open and close prices of the mother
bar. This kind of arrangement of the two bars symbolizes a rising tendency
on the market.
However, I would like to point out that in this situation I am not
concerned with whether a given bar is rising or falling. The direction of the
close of certain bars in the formation will be tested in another filter.
Diagram 10.3 presents four variants which are in line with these
assumptions.
Diagram 10.3. Uptrend type of formation

DOWNTREND TYPE OF IB FORMATION

A downtrend IB formation appears when the open and close prices of the
inside bar are below the open and close prices of the mother bar. This
arrangement of the two bars symbolizes a declining tendency on the
market. As before, the direction of the close of particular bars within the
formation is of no concern for me.

Diagram 10.4. Downtrend type of formation

CONSISTENCY OR INCONSISTENCY WITH DIRECTION OF BREAKOUT

The next thing which should be discussed before we proceed to the testing
is the issue of the direction of the breakout from the formation types we
have just discussed. For the purposes of the test I have adopted the
assumption that the breakout can be either consistent or inconsistent with
the close. While in the case of the interior and exterior type of IB
formations this is insignificant (in this respect I consider those formations
as neutral), in the context of uptrend or downtrend type of IB formations
this has certain implications.
In the following test I have taken four categories into consideration:
– interior type of IB formation – both uptrend and downtrend breakouts

– exterior type of IB formation – both uptrend and downtrend breakouts

– IB formation with consistent breakout: uptrend type of IB formation –

uptrend breakout and downtrend type of IB formation – downtrend
breakout (breakout in the direction of the tendency between the two
bars meant to confirm the investor’s mood on the market)
 – IB formation with inconsistent breakout: uptrend type of IB formation
– downtrend breakout and downtrend type of IB formation – uptrend
breakout (breakout in the direction of the tendency between the two
bars meant to confirm the investor’s mood on the market)

STATISTICAL ANALYSIS

Analysis of a short-term approach

Table 10.1. Types of IB formation in base of relation of open and close of bars constituting
an inside bar formation – short-term approach
Formation types Percent of Total trades Profit Maximum Average Rate of re-
winning drawdown trade turn
transactions
All IB 51.1% 28,647 $1,624,860 $-62,090 $57 2,617%
Interior type of IB formation 50.8% 12,013 $615,432 $-38,261 $51 1,609%
IB formation with consistent 51.1% 5,369 $315,616 $-33,068 $59 954%
breakout
IB formation with inconsistent 51.4% 5,779 $316,597 $-48,827 $55 648%
breakout
Exterior type of IB formation 51.7% 1,465 $58,386 $-16,911 $40 345%

Discussion of results:

1. First, I would like to remark that all categories are profitable but
display a weaker rate of return than unfiltered IB. Parameters like
percent of winning transactions or average trade are closer to or lower
(exterior type of IB formation) than those for the sample as a whole.
Thus, certain differences among particular categories can be
discerned, but I would not treat this filter as critical (as the trend filter
could be regarded in some situations). In my trading, I would rather
use it as an assumption to reinforce or weaken a given IB formation.
For example, when considering the table above we may draw the
conclusion that if I had to assess two similar IB formations, and I was
not sure which of them to choose, I would certainly show a preference
to IB formations with consistent breakout over external types of IB
formations.
2. The interior type of IB formation achieved the best result. Successive
places which generated similar results were IB formations with
consistent and inconsistent breakouts. Here it should be noted that the
declining rate of return is not dependent on the effectiveness of the
formation, but rather on its popularity in the chart. The three types of
IB formations listed above achieved similar average trade, so the
difference in the final results can only be a product of the frequency of
signals. The interior type of formation constitutes 41% of the total; IB
with consistent breakout – 19%; IB with inconsistent breakout – 20%
(the exterior type of IB formation comprised only 5% of all cases).
3. The exterior type of formation is by far the worst performer. It
achieves the lowest rate of return (345%), but also – and more
importantly – an average trade of only $40. What could be the cause
of this? When training traders, I frequently invoke the analogy of
a spring. If the spring is compressed (low volatility on the market,
interior type of IB formations are emerging), we can expect that the
spring will finally pop open and the price will jump to levels far away
from those actually recorded. However, if the spring is already
 stretched out (an exterior type of IB formation is emerging), we
should rather expect the disappearance of volatility on the market, and
by the same token expect that any potential breakout will not push the
price away.

Analysis of a medium-term approach

Table 10.2. Types of IB formation in base of relation of open and close of bars constituting
an inside bar formation – medium-term approach
Formation types Percent of Total trades Profit Maximum Average Rate of re-
winning drawdown trade turn
transactions
All IB 50.3% 18,234 $954,598 $-336,251 $52 284%
Interior type of IB formation 50.2% 9,561 $406,751 $-186,361 $43 218%
IB formation with consistent 50.4% 4,790 $210,580 $-161,014 $44 131%
breakout
IB formation with inconsistent 49.9% 5,113 $58,930 $-200,573 $12 29%
breakout
Exterior type of IB formation 50.4% 1,417 $-14,953 $-88,345 $-11 -17%

Discussion of results:

1. Generally, we should understand that the strategy in the medium-term

approach operates worse than in the short-term approach. This is more
evidence that IB is most effective in quick transactions, immediately
following its emergence. Three of the four tests are profitable, but we
should observe that no filter generated a better result than all of the
unfiltered IB formations taken together.
2. By far, the best results were generated by the interior type of IB
formation. It recorded a rate of return of 218%, which is not much
worse than that of the unfiltered IB formations. Again, however, I am
not surprised by the effectiveness of this formation. The interior type
of IB formation is something like a smaller consolidation nested
within a greater one. A natural consequence of such a tightly-squeezed
spring can only be a sudden breakout.
3. The next place in the table was occupied by the IB formation with
consistent breakout, whose average trade was $44, which is close to
 the average trade of the interior type IB formation. The rate of return
of 131% is also much higher than in the other two cases. I would say
the better results come because the IB formation with consistent
breakout is one whose relation of open and close creates a sort of
small uptrend or downtrend. The effect of a breakout consistent with
that tendency comes in the form of greater reliability and range of the
movement.
4. I would treat the results generated by IB with consistent breakout
neutrally. They are far worse than the two tests previously discussed,
but they remain positive. This cannot be said of the exterior type of IB
formation. In this case, the rate of return and average trade are
negative, which I view as a clear sign of weakness.
5. In analyzing the medium-term approach, my attention was drawn to
the quantitative distribution of IB in particular categories which, it
should also be said, is similar in all three approaches. First is the
interior type of IB formation, then IB with consistent breakout and
inconsistent breakout, and the least – exterior type of IB formation. It
should be kept in mind that IB presents price movement at a smaller
time frame. By the same token, since the market most frequently
moves horizontally (the general opinion is that trends are present only
30% of the time), it is natural that the interior type of IB is the most
common formation.

Analysis of a long-term approach

Table 10.3. Types of IB formation in base of relation of open and close of bars constituting
an inside bar formation – long-term approach
Formation types Percent of Total trades Profit Maximum Average Rate of re-
winning drawdown trade turn
transactions
All IB 50.7% 12,633 $693,613 $-264,349 $55 262%
IB formation with consistent 51.4% 4,259 $461,376 $-109,500 $108 421%
breakout
Exterior type of IB formation 49.8% 1,369 $151,922 $-74,407 $111 204%
Interior type of IB formation 50.3% 7,724 $212,471 $-320,881 $28 66%
IB formation with inconsistent 50.3% 4,469 $-128,923 $-364,984 $-29 -35%
breakout
Discussion of results:

1. Results in the long-term approach came as a surprise, as two of the

tests unexpectedly generated exceptionally good results. The two
surprises came from the IB formation with consistent breakout
(average trade: $108[10]) and interior type of IB formation (average
trade: $111). To be honest, I do not know where these above-average
results come from. I respect them, but because I do not understand
them and I am unable to explain them, in real trading I would
probably not bother with using the results from this filter. This does
not change the fact that other traders might have different opinions.
However, in this case I would recommend a more thorough analysis of
the specific transactions captured in the tests.
2. I was disappointed by the internal type of IB formation. In the two
preceding approaches it performed well, but in this case the results
were below average. I am unable to explain why; sometimes the
market just enjoys throwing a curveball.
3. I would offer a singularly negative assessment of the IB formation
with inconsistent breakout. This comes as no surprise however, as in
all of the approaches this category has generated weak results.

RECOMMENDATIONS:

1. The filter under analysis has again confirmed that the predictive
power of IB is at its greatest in the short-term approach. Because in
this case all tests generated a positive result, I would not exclude any
category, even one performing slightly worse. However, I would take
certain results in consideration if I were faced with the necessity of
comparing two similar IB formations and needed to choose only one
of them in opening a transaction.
2. In all three approaches, IB with consistent breakout generated positive
results, and was either best or second-best. A breakout consistent with
the direction of the general trend thus generates a satisfactory and
 stable advantage. Stability is what we should be seeking in day-to-day
trading.
3. I also have a positive opinion of the interior type of IB formation.
While its results in the long-term approach were worse, it should be
kept in mind that in other approaches it performed excellently. In my
view it should retain its privileged position, but I would be aware that
in one of the three approaches it surprised me negatively.
4. The interior type of IB and IB with inconsistent breakout generate
confusing results – sometimes a bit under zero, sometimes a bit over.
This comes as no surprise to me, as both types of IB present situations
in which there is not clarity as to the future price trend.
So how should we behave when a filter generates unstable
indications? Should it be applied in such a situation? It should
certainly be observed, but we should remember to take special care
when using it. Transaction systems should not be developed using
exclusively unstable filters (even if they give positive indications).
 Chapter 11
Consistency of a Breakout
with the Direction of the Close of the Last Bar

The expression “breakout consistent with the direction of the close”

would seem rather intuitive, but for clarity’s sake I would like to briefly
elaborate on it. Let us do so by taking a look at Diagram 11.1. The inside
bar in the presented IB formation is a bear bar, thus when the breakout is
a downward movement, we can label it as consistent with the direction
of the close of the bar. Analogically, Diagram 11.2 depicts a situation
where the breakout is inconsistent with the direction of the close. The
inside bar is a bear bar, but the movement completing the formation
infringes its high rather than its low.
In analyzing this filter, I wanted to test whether a breakout in the
direction of the tendency presented by the second bar of the formation
has any influence on the general effectiveness of the IB. Intuitively one
might attempt to explain that, for example, if the second bar is an
upward one, and as a result the bulls are in control over the short-term,
then any potential dynamic movement upward should be more reliable.
However, will reality confirm this assumption?
Diagram 11.1. Breakout consistent with the direction of the close of the last bar

Diagram 11.2. Breakout inconsistent with the direction of the close of the last bar

STATISTICAL ANALYSIS

Analysis of a short-term approach

Table 11.1. Consistency of breakout with direction of the close of the last bar – short-
term approach
Consistency of breakout Percent of Total trades Profit Maximum Average Rate of re-
with direction of close winning drawdown trade turn
transactions
All IB formations 51.1% 28,647 $1,624,860 $-62,090 $57 2,617%
IB with consistent breakout 50.9% 19,603 $972,956 $-70,585 $50 1,378%
IB with inconsistent breakout 51.0% 12,598 $573,977 $-48,036 $46 1,195%

Discussion of results:

1. Each type of breakout is profitable, but none of them generate a rate

of return equivalent to that of the unfiltered IB. In practice, this
means that under this approach the filter does not have any
significant predictive value, because none of the tested groups of IB
distinguish themselves either positively or negatively.
2. Also, it is worth observing that parameters such as percent of
winning transactions, average trade, and even rate of return are
rather close, but it should be acknowledged that breakout consistent
with direction of the close was slightly better.

Analysis of a medium-term approach

Table 11.2. Consistency of breakout with direction of close of the last bar – medium-
term approach
Consistency of breakout Percent of Total trades Profit Maximum Average Rate of re-
with direction of close winning drawdown trade turn
transactions
All IB formations 50.3% 18,234 $954,598 $-336,251 $52 284%
IB with consistent breakout 50.1% 14,033 $916,649 $-231,069 $65 397%
IB with inconsistent breakout 50.1% 9,958 $166,726 $-262,065 $17 64%

Discussion of results:

1. Rates of return in the medium-term approach are generally worse

than in the short-term. The filter under consideration therefore
confirms the earlier theory that IB works best in a short time
horizon.
2. In the short-term approach, both types of breakouts are profitable,
but the differences between results are much more significant. For
example, breakout consistent with the direction of the close
generates a sixfold-higher rate of return than the inconsistent
 breakout. The tendency which was barely visible just a moment ago
has become very clear in the medium-term approach.
3. It is worth observing that the rate of return for breakouts consistent
with the close is greater than for all unfiltered IB formations. In this
approach, a close consistent with the breakout would seem to be
particularly attractive.
4. The breakout inconsistent with the direction of the close produced
an average trade of $17; nevertheless, I would not consider this type
of formation negatively, but rather neutrally.

Analysis of a long-term approach

Table 11.3. Consistency of breakout with direction of close of the last bar – long-term
approach
Consistency of breakout Percent of Total trades Profit Maximum Average Rate of re-
with direction of close winning drawdown trade turn
transactions
All IB formations 50.7% 12,633 $693,613 $-264,349 $55 262%
IB with consistent breakout 50.4% 10,439 $840,149 $-300,674 $80 279%
IB with inconsistent breakout 51.0% 8,017 $497,961 $-193,966 $62 257%

Discussion of results:

1. In the long-term approach we see a situation similar to that of the

short-term. The results generated by particular groups of IB
formations are similar, with a slight advantage of the breakout
consistent with the direction of the inside bar close. It should also be
observed that the rates of return in both tests are very close to the
unfiltered IB formations, which, in the context of a smaller number
of signals, greater average trade value, and smaller drawdown,
should be interpreted positively.

RECOMMENDATIONS:

1. In each of the three approaches, breakouts consistent with the

direction of the close generated better results than those of
inconsistent breakouts. Nevertheless, in two of the three cases the
differences were not very large. Thus, in real trading the filter under
discussion would not be of significant value. Indeed, I would be
aware of the slight advantage possessed by consistent breakouts
over inconsistent ones, but I would probably not open a given
position dependent on it, and I would certainly not base
a transaction system around it.
 Chapter 12
Distance From Close of the Inside Bar
to the Breakout Level

A certain observation led me to examine this filter. I noticed it many years

ago, because it is present in all markets and in all time frames.
When analyzing charts I noticed that breakouts are more successful
when the close of the last bar is located near the level of the breakout.
What could be the source of this characteristic? My explanation is that
when we find ourselves far from the level of the breakout, the
overwhelming majority of the energy from that breakout is not used to
drive the price from the maximum that has been exceeded (that is, to earn
money), but rather to reach that maximum. When we are far away from the
level of the break out, there is a stronger possibility that the breakout bar
will not be in a position to close much higher (in the case of a long
position) than the level that has been violated.
A second observation is linked with this first one: in my view, it is the
case that the close of a price bar is frequently a turning point on the market.
In the same way, if a breakout emerges in the course of a given bar I would
say that, until the moment it closes, traders are safe. A new force with the
capacity to change the face of the market, if such a force appears, will
likely do this only at the beginning of the next bar. With these two
observations in mind, the best situation for a trader is when a breakout bar
closes far away from the breakout level. In this case a potential pullback
after a dynamic movement will be far less painful in financial terms.
In this chapter we will examine whether the preceding observations are
reflected in the existing reality of the market. Before doing this, however,
we still need to determine how we will define what constitutes a close at
a “short distance” or “long distance” in reference to the breakout level. To
this end, the inside bar will be divided into two equal halves. For example,
if the close of a given bar is located in the upper half, and at the same time
the breakout occurs at the initiative of the bulls, we will determine that the
close occurred at a short distance from the breakout (Diagram 12.1 A).
However, if the close is located in the lower half, while the breakout
remains headed upward, we will say that the close was located at a long
distance from the breakout (Diagram 12.1 B). Conversely, the reverse
naturally applies to short transactions.

Diagram 12.1. (A) Short distance from close of inside bar to breakout level; (B) long
distance from close of inside bar to breakout level

In analyzing this filter, we should pay attention to its similarity to the

filter presented in the preceding chapter. It is easy to imagine that in many
cases, an IB formation with a breakout consistent with the direction of the
close will at the same time be an IB with a close a short distance from the
breakout. This is not true in every case, of course, but it occurs with
enough frequency that it should be explored. On the other hand, IB with an
inconsistent close will frequently be a long distance from the level of the
breakout. I treat the two filters separately, but they do have much in
common.

STATISTICAL ANALYSIS

Analysis of a short-term approach

Table 12.1. Distance of last bar close from breakout level – short-term approach
Distance of close from Percent of Total trades Profit Maximum Average Rate of re-
breakout level winning drawdown trade turn
transactions
All IB formations 51.1% 28,647 $1,624,860 $-62,090 $57 2,617%
Close short distance from 51.1% 20,744 $1,116,789 $-59,299 $54 1,883%
breakout
Close long distance from 50.4% 11,700 $421,684 $-85,806 $36 491%
breakout

Discussion of results:

1. Each type of close is profitable, but the average trade value and rate
of return are better or much better in respect of the close at a short
distance to the breakout. Nevertheless, as in the case of the previous
filter, each of the tests individually generated a worse result than all of
the unfiltered IB formations. I would thus not build a transaction
strategy based on this filter, and I would only use it for reinforcing or
weakening a given IB formation.
2. In the short-term approach the postulate given at the beginning of the
chapter was confirmed, that is, IB formations with a close located
a short distance to the breakout level lead to more reliable breakouts
(they generate better results in tests regardless of the parameter we are
comparing). In these situations we may assume that the lion’s share of
trading in the course of a breakout bar occurs above (in buy
transactions) the breakout level, which gradually drives the price away
from it.

Analysis of a medium-term approach

Table 12.2. Distance of last bar close from breakout level – medium-term approach
Distance of close from Percent of Total trades Profit Maximum Average Rate of re-
breakout level winning drawdown trade turn
transactions
All IB formations 50.3% 18,234 $954,598 $-336,251 $52 284%
Close short distance from 50.2% 14,616 $852,338 $-314,370 $58 271%
breakout
Close long distance from 49.9% 9,354 $171,900 $-349,821 $18 49%
breakout

Discussion of results:
 1. Rates of return in the medium-term approach are generally worse than
results generated in the short-term approach. The filter under
discussion confirms the previous hypothesis that IB works best in
short time horizons.
2. In the medium-term approach every test is profitable, but the
differences across results achieved in specific types of formations are
greater than what we have seen previously. It could be assumed that
this dispersion of results is associated with a weakening predictive
value of IB, and by the same token with an increased level of
randomness, which is additionally correlated with transaction
duration.
3. The IB formation with a short distance to the breakout is better in
every aspect than that with a long distance to the breakout. The
average trade value is more than three times greater, while the rate of
return is five times higher. I would not exclude an IB type that
generates weaker results from my trading, but I would assign
somewhat less reliability to it.

Analysis of a long-term approach

Table 12.3. Distance of last bar close from breakout level – long-term approach
Distance of close from Percent of Total trades Profit Maximum Average Rate of re-
breakout level winning drawdown trade turn
transactions
All IB formations 50.7% 12,633 $693,613 $-264,349 $55 262%
Close short distance from 51.4% 10,767 $1,247,929 $-170,290 $116 733%
breakout
Close long distance from 49.7% 7,614 $99,904 $-326,589 $13 31%
breakout

Discussion of results:

1. In the long-term approach each test is also profitable, but an even

greater difference among results can be observed than in the medium-
term approach. The difference between the average trade value across
certain types of IB formations is much more visible ($12 versus $116).
 2. For a third time in a row the best results were achieved by IB
formations a short distance from the breakout. While the results are
consistently positive (without accounting for transaction costs), the
31% rate of return is significantly worse than the results achieved in
this analysis and in the two tests performed for the remaining
approaches. Nevertheless, I would take a neutral approach to closes at
a long distance from the breakout rather than a negative approach.

RECOMMENDATIONS:

1. In every approach IB formations with a breakout at a short distance

performed better or far better than those with a breakout at a long
distance. This fact means that the recommendation of IB formations
with a breakout at a short distance seems stable and reliable.
2. When we analyze IB formations with a breakout at a long distance,
we should apply special caution. In two of the three approaches the
achieved results were relatively weak – they allowed us to earn just
slightly more than the transaction costs.
 Chapter 13
Relation of the Close of Bars Forming an IB

The next filter is a natural consequence of the preceding ones, and we

will continue to analyze the shape of the formation. This time, however,
we will examine the relations present among the bars comprising an IB
formation. In the same way, we will test several versions of the
formation, which will differ from one another by the order in which up
and down bars are arranged. Later on, I will list the potential
configurations that will then be programmed into Trade Navigator and
check their effectiveness.
Diagram 13.1 gives an example of two bars with closes in the
direction of the breakout. By the same token, in the case of the upward
movement, the two bars are bullish, while in the case of the downward
movement they are bearish.
The natural opposite of the situation presented above is one in which
the close of both bars is in the same direction, while the breakout moves
in the opposite direction. Diagram 13.2 presents two potential examples
of the case under discussion.

Diagram 13.1. Close of both bars in the direction of the breakout

Diagram 13.2. Close of both bars in the opposite direction from the breakout

The third possibility is a formation in which the first bar closes in one
direction, while the second bar closes in the opposite direction, and the
breakout occurs in the direction of the close set out by the second bar in
the formation. These situations are presented in Diagram 13.3.

Diagram 13.3. Both bars with opposite closes – breakout in the direction of the second
bar

The fourth and final version is the opposite of the third. In this case,
both bars again close in the opposite direction, but the breakout moves in
the direction of the first bar rather than the second. These situations are
presented in Diagram 13.4.
Diagram 13.4. Both bars with opposite closes – breakout in the direction of the first bar

STATISTICAL ANALYSIS

Analysis of a short-term approach

Table 13.1. Relation of bars comprising the formation – short-term approach

Relation of bars in Percent of Total trades Profit Maximum Average Rate of re-
formation winning drawdown trade turn
transactions
All IB formations 51.1% 28,647 $1,624,860 $-62,090 $57 2,617%
Both closes in direction of 50.7% 6,019 $323,083 $-30,530 $54 1,058%
breakout
First close – inconsistent 51.1% 13,338 $642,631 $-75,979 $48 846%
with breakout, second –
consistent
Both closes in the opposite 52.1% 3,822 $282,467 $-42,408 $74 666%
direction from breakout
First close – consistent with 50.8% 8,628 $291,346 $-45,123 $34 646%
breakout, second close –
inconsistent

Discussion of results:

1. In the short-term approach each of the bar configurations generated

a profit. The disparity across results is relatively small, while
individual categories offer rates of return lower than that of
unfiltered IB formations. Thus, in this case the filter does not
provide conclusive indications, which in practice means that it does
 not eliminate any particular type of IB; at the same time, however, it
also does not provide a greater degree of support to any of them.
2. One potentially interesting observation is the fact that the most
frequently occurring filter is the configuration in which the two bars
comprising the formation have opposite closes, and the breakout
moves in the direction of the second bar (this observation would
seem a logical one, considering that the breakout can be
a continuation of the tendency that began at the end of the IB
formation’s emergence). This category generated 47% of all signals.
The least frequent, however, is the IB formation in which both
closes go in the direction opposite the breakout (only 13%).
3. The highest rate of return, at 1,058%, was recorded by the IB
formation with two closes consistent with the breakout. This good
result is not a surprise to me, as it can be expected when there is full
harmony in the market. A parameter distinguishing itself positively
is drawdown – far lower than in the remaining cases. Average trade
and percent of winning transactions are close to those achieved by
unfiltered IB. I take a positive view of this filter, although it does
not have strategic significance in my trading – what I have
described in point 1 above.
4. I was surprised, however, by the result of the IB formations in
which both closes are opposite to the breakout. It might intuitively
seem that such formations would not generate results that
distinguish them positively. That being said, the market does like to
surprise us. While the rate of return – 666% - is by no means
spectacular, it was generated in the course of just 3,822 transactions.
How, then, can we explain average trade at a level of $74? The most
likely explanation is that the first two bars, e.g. bullish ones, are
preparing the market for an upward-moving breakout. When this
fails to occur, and prices begin dropping, surprised investors exit
their losing positions in a panic, dragging prices down with them
and generating profit for investors taking short positions.
Analysis of a medium-term approach

Table 13.2. Relation of bars comprising the formation – medium-term approach

Relation of bars in Percent of Total trades Profit Maximum Average Rate of re-
formation winning drawdown trade turn
transactions
All IB formations 50.3% 18,234 $954,598 $-336,251 $52 284%
Both closes in direction of 50.9% 5,351 $376,555 $-121,623 $70 310%
breakout
First close – inconsistent 49.6% 10,481 $528,703 $-234,262 $50 226%
with breakout, second –
consistent
Both closes in the opposite 49.6% 3,517 $93,884 $-100,178 $27 94%
direction from breakout
First close – consistent with 49.9% 7,524 $32,521 $-272,405 $4 12%
breakout, second close –
inconsistent

Discussion of results:

1. In the medium-term approach each IB formation is also profitable.

It should, however, be pointed out that rates of return are lower than
in the short-term approach. This is more proof that a short time
horizon functions best in the context of IB formations.
2. In the medium-term approach the disparity across results was
greater as well (the difference between the highest rate of return
310% and the lowest 12% is 25 times). This is likely caused by the
fact that the longer we stay in the market, the greater the impact of
volatility on our results.
3. Again, the best type of IB formation was that of two closes
consistent with the direction of the breakout. This filter not only
achieved the highest rate of return, but also outperformed unfiltered
transactions (310% versus 284%). In addition, this type of formation
achieved the highest average trade, as well as the best percent of
winning transactions. It is the clear winner.
4. A good result was also recorded by IB formations with two opposite
closes and a breakout consistent with the second bar. This filter
achieved a rate of return of 226%, which was possible inter alia due
 to relatively frequent signals – this was the largest group from
among the types tested.
5. I take a neutral view of the two remaining categories. IB with two
closes opposite the breakout failed to repeat its earlier successes.
After deducting transaction costs, the average trade of $27 will not
be very attractive. All the more so in the case of the $4 result – in
the IB with opposite close and breakout consistent with the first bar
– after fees and any potential delays, this number drops below $0.

Analysis of a long-term approach

Table 13.3. Relation of bars comprising the formation – long-term approach

Relation of bars in Percent of Total trades Profit Maximum Average Rate of re-
formation winning drawdown trade turn
transactions
All IB formations 50.7% 12,633 $693,613 $-264,349 $55 262%
Both closes in direction of 51.5% 4,712 $680,657 $-133,974 $144 508%
breakout
First close – consistent with 51.9% 6,163 $394,315 $-188,564 $64 209%
breakout, second –
inconsistent
First close – inconsistent 49.4% 8,289 $262,381 $-644,164 $32 40%
with breakout, second close
– consistent
Both closes in the opposite 49.0% 3,202 $-92,979 $-228,320 $-29 -41%
direction from breakout

Discussion of results:

1. In the long-term, the filter does continue to demonstrate a certain

level of stability, but it should be observed that one type of IB
generates results dipping below zero. The distribution of results is
even more widely spread-out than in the two preceding cases.

2. For a third time, the strongest type of IB turned out to be the

formation with two closes consistent with the breakout. This filter
recorded a 508% rate of return (in comparison to 262% for
unfiltered IB formations), the highest average trade result ($144),
 and the best profit, which, with ⅓ of all IB transactions recorded
virtually no decline ($680,000 versus $693,000). Let us recall that
the less time we are on the market, the less we are exposed to risk.
3. A good performer came in the shape of formations with inconsistent
closes and breakout consistent with the direction of the first bar in
the formation. The two remaining filters work much worse, while
the formation of two opposite closes brings a rate of return at a level
of 41%. Again, we were unable to replicate our good results from
the short-term approach. There are probably two explanations for
this. The first is that the positive result may be the effect of
randomness on the market. The second is that the advantage over
the short time horizon could be the product of a temporary
imbalance on the market, which allows us to take a temporary and
ephemeral lead. In other words, an imbalance in orders allows us to
take profits, but transactions should not be kept open for too long.
Traders desiring to learn which of these explanations is most
accurate should explore the issue on their own and perform
supplementary tests.

RECOMMENDATIONS:

1. I recommend using the formation with two closes in the direction of

the breakout. These types of formations gave the best results in all
three approaches, which attests to the stability and reliability of that
filter.
2. Regarding the remaining types of IB, the indications were
somewhat ambiguous – individual approaches generated
inconsistent conclusions, which is why I would be particularly
careful when applying these filters in real trading. Here I would like
to again remind you that in my research I am never seeking
a “magic bullet” universal solution which will work the best on any
given market or at any given moment. Of course, I do want to have
filters with good results, but I am equally interested in stability. This
 means that when the market slightly changes its character, the stable
filter I have selected is more likely to continue producing positive
results, or at least to protect me from losses.
3. The filter under discussion here is not a necessary one to use.
I would probably not use it as a foundation for building a trading
strategy. If I did let myself be tempted, then I would only do it in the
case of IB formations with both closes going in the direction of the
breakout.
 Chapter 14
Multiplicity of the Inside Bar

In the previous chapters we have discussed only single IB formations,

basically assuming that after the emergence of a formation a third bar
generates a breakout in one or the other direction. This is the most common
situation, but there are also situations in which no breakout occurs. In this
case, the consolidation becomes more drawn out, which we see on charts
as a series of successive bars nested inside the ones which came before
them.
An extended horizontal movement leads to the market’s “spring”
winding tighter and tighter. The longer this goes on, the more sudden the
return to the balance which occurs after the spring unwinds. In other
words, before calm returns to the market, the spring will go from one
extreme state to the next, leading to a breakout. In the filter below we will
explore whether an increasing number of traders trapped in the market with
orders at the extremes of a horizontal movement in fact impact the
reliability and power of the breakout.
In Diagram 14.1 I present a double (frequently referred to as Shark 32)
and triple IB, while Diagram 14.2 depicts a price chart where I have
highlighted this formation on a real market. In this test I have focused only
on double and triple formations, but it should be noted that the market
sometimes experiences situations in which a consolidation extends beyond
four bars. I am aware of this, and I have deliberately avoided examining
these types of cases. They are rare enough that even if they did generate
satisfactory results, I would personally not have the patience to wait for the
right signal (which would occur once every couple of months). In the
following tests we will see how much the number of transaction
indications drops together with the extended consolidation.
Diagram 14.1. (A) Double and (B) triple IB

Diagram 14.2. Example of multiple IB in a market

STATISTICAL ANALYSIS

Analysis of a short-term approach

Table 14.1. Multiplicity of IB formation – short-term approach
IB multiplicity Percent of Total trades Profit Maximum Average Rate of re-
winning drawdown trade turn
transactions
Single IB 51.1% 28,647 $1,624,860 $-62,090 $57 2,617%
Double IB 49.5% 2,318 $209,879 $-17,544 $91 1,197%
Triple IB 42.3% 196 $14,612 $-8,557 $75 171%

Discussion of results:

1. The first conclusion, which seems to jump out at us, concerns the
declining number of IB formations that accompanies the lengthening
duration of the consolidation. Double IB formations constitute only
8% of all formations, while triple IB – a mere 0.7%. In practice, this
means that in the daily time frame a double IB occurs on one market
an average of once every five months, while a triple IB appears once
every five years (!). Who among us has enough patience to wait such
a long time for a transaction signal? Even for less active traders, five
years is probably too trying of a wait.
2. Relatively good results were recorded by the double IB formation.
While the percent of winning transactions did decline (as well as
profit and rate of return), this was made up for by improving the
average trade result, which jumped to $91. In the short-term approach
we can thus assume that the duration of a consolidation has a positive
impact on the strength of the breakout. The number of signals does not
impress, but we may give in to the temptation to create a transaction
strategy on multiple markets.
3. In the case of the triple IB we can also observe positive effects arising
from an extended consolidation. Here, however, we must pay attention
to the significant drop in the percent of winning transactions (to
42.3%) and average trade, which did rise in comparison to the single
IB, but fell in relation to the double IB. In addition, we should also
note the steep decline in the number of signals – 196 over 10 years on
82 markets is a very poor result. This is why I would not choose to
develop a transaction strategy solely on the basis of triple IB. Of
course, if a triple IB appears on the market, I do not ignore it, but I am
 more aware of the increased potential for a breakout, and if the
circumstances are right I will conclude a transaction.

Analysis of a medium-term approach

Table 14.2. Multiplicity of IB formation – medium-term approach

IB multiplicity Percent of Total trades Profit Maximum Average Rate of re-
winning drawdown trade turn
transactions
Single IB 50.3% 18,234 $954,598 $-336,251 $52 284%
Double IB 50.5% 2,194 $279,080 $-72,054 $127 387%
Triple IB 51.3% 189 $54,884 $-17,889 $290 307%

Discussion of results:

1. The issue of the declining number of signals coupled with the

extended consolidation also affects the medium-term approach and
will also be reflected in the long-term approach. There is nothing I can
add here to what I have already written.
2. In the medium-term approach the double IB formation generated
better results in every area – percent of winning transactions, rate of
return, and average trade value ($127 compared to $52) were all
better. What led to this significant improvement? I think that it may be
associated with the duration of the consolidation. It would seem
logical that if the consolidation is short, the breakout will also not last
long. However, if the consolidation is long (as is the case with double
and triple IB formations), it is reasonable to assume that the breakout
will also be extended – both in terms of the range and the duration. In
other words, when exiting after one bar in the first test we limited our
profit, while when exiting after five (under the medium-term
approach) we have made better use of the momentum present on the
market.
3. The triple IB confirms the hypothesis given above. The longer
consolidation led to an even stronger breakout, which in turn led to
another improvement in results. For example, average trade amounted
to $290 (!) as compared to $52 and $127. Percent of winning
 transactions was also satisfactorily high, at 51.3%. The small number
of transactions, however, remains a problem. For this reason,
I previously took a dimmer view of the triple IB; now, however, I am
of the view that in the medium-term approach we might be a bit
bolder in using a four-bar horizontal movement in real trading. I do
this because of the excellent results attained by this type of IB. We
should note that in the short-term approach the triple IB displayed
worse percent of winning transactions, as well as average trade value
in comparison to the double IB.

Analysis of a long-term approach

Table 14.3. Multiplicity of IB formation – long-term approach

IB multiplicity Percent of Total trades Profit Maximum Average Rate of re-
winning drawdown trade turn
transactions
Single IB 50.7% 12,633 $693,613 $-264,349 $55 262%
Double IB 52.7% 2,034 $391,989 $-64,808 $193 605%
Triple IB 47.2% 180 $56,687 $-22,321 $315 254%

Discussion of results:

1. Decline in number of signals coupled with extended consolidation.

2. In the long-term approach the double IB formation has better results
in every area (percent of winning transactions, average trade, rate of
return) than single IB. The average trade here was $193, which
confirms that in the case of longer consolidations it is important to
remain within the dynamic movement long enough to take advantage
of the full potential of the breakout (in the medium-term approach the
average trade was $127, thus $66 lower than in the present test).
3. In respect of triple IB the results are also good, but not outstanding.
Let us recall that in the medium-term approach, both parameters were
improved (average trade and percent of winning transactions), and
only for this – exceptionally – I decided to give a positive
recommendation of these results. In this case, only one attribute was
improved (average trade), whereas the other (percent of winning
 transactions) declined. Owing to muddiness in the interpretation of the
results, and also to the small number of signals, I would treat the triple
IB formation exactly the same as in the short-term approach: be aware
of the potential they hold, but do not develop an investment plan on
their basis.

RECOMMENDATIONS:

1. In all three approaches, the double IB had a positive effect on the

results achieved. This attests to the stability and reliability of the filter.
2. Triple IB in each of the three approaches improved the average trade
result, but the remaining parameters were not always better. If we join
this to the small number of transaction indications, it turns out that
there is not really any sense in employing the triple IB formation in
creating an independent investment strategy – I would, however, be
aware of the potential force of the breakout which is gradually
accumulated in the course of its development.
 Chapter 15
Volatility

In this chapter we will explore how volatility impacts the effectiveness of

the IB formation. Will it perform better in moments when the market is
hot, flush with emotion and prices are fluctuating, or perhaps in moments
of calm, dare we even say: in the doldrums?
To conduct our tests, we must adopt a method for describing volatility.
I suggest employing the Average True Range (ATR) indicator. This tool
fully meets my expectations and is also available for the majority of
trading platforms, as well as other software used for market analysis. Its
construction is quite simple. This indicator measures the price range for X
periods (difference between highest and lowest price), and then calculates
their average value. For example, if the volatility for the preceding day was
10 points, while for today it is 5 points, the ATR (2) value is 7.5 points. In
my own trading, I generally apply ATR for 20 periods. This is a round
number which is roughly equivalent to the number of trading sessions in
a month. By no means am I seeking the ideal parameter, which, as we
know, does not exist. Indeed, particular values of an indicator can function
better over a short period of time and on a specific market; let us keep in
mind, however, that the objective of a trader is not to maximize profit, but
to maintain a stable profit margin. When using ATR, I do not apply an
average from an overly small number of price bars (say, 5), because the
readings would be too “jumpy”, whereas with an overly large sample of
price bars I would have trouble understanding how volatility from a half-
year ago (over 100 days) impacts the behavior of prices today. I think 20
periods is a sensible solution.
Diagram 15.1. ATR indicator

Diagram 15.1 depicts the behavior of the ATR (20) in the context of a price
chart. The chart presents stock quotes from the E-mini S&P 500. At the
top-left corner of the chart, the price of the contract is locked in a sideways
trend, and the value of the tool we are discussing records values between
19 and 29. The market is relatively calm, so volatility is low. Next, a strong
downward breakout occurs. The large falling bars mean that ATR readings
are reaching ever-greater values, as high as 50 points. After a three-day
drop, the price again begins to stabilize, and the ATR line moves more
horizontally, entering into a slight decline just at the edge. To summarize
this chart description, we can say that the lower the ATR, the lower the
volatility on the market, while higher ATR indicate a greater tendency
towards significant fluctuations. The ATR can be used in many different
ways, such as for managing stop-loss orders or for forecasting local highs
and lows. I encourage readers interested in the subject to expand their
knowledge.

TESTING METHOD

The inside bar of every IB formation will be measured individually, while

its range will be compared to the reading for a given day of the ATR (20).
In this manner, the IB formation will be divided into four equally populous
groups: very small IB, small IB, large IB, very large IB. Why an equal
number? Because I want to present the tests in the most trustworthy
manner possible. Aware that any other possible division of the groups
would be subjective, and could slow the process of arriving at conclusions,
I decided to apply the solution just described. In order to be certain that the
testing method is fully understandable, below I have presented a sample
calculation.
Maximum price of inside bar: 100 points
Minimum price of inside bar: 90 points
Range of inside bar: 100 – 90 = 10 points
ATR (20): 20 points
Relation of inside bar to market volatility: 10 ÷ 20 = 0.5
IB classification: depending on the results of the remaining IB
formations, this IB would be assigned to one of four equally populous
groups.
Here it should be emphasized that the higher the value of the calculated
indicator, the more the inside bar approaches in range the volatility present
on the market. For example, let us imagine that the range of the inside bar
in the above example is 20 points rather than 10 points. In this case, we
would obtain an equation of 20 ÷ 20, while the calculated value would be
twice greater, that is, 1. In the analysis of results I will soon present, it is
important to be aware that we are not examining the size of the inside bar,
but only the relation of its range to the volatility present in the market.

STATISTICAL ANALYSIS
Analysis of a short-term approach
Because the number of IB formations in each analyzed approach is
different, the need to classify certain formations into equal-sized groups
requires us to adopt different thresholds for the adopted categories. Under
the short-term approach:
– very small IB is an IB formation whose range in relation to volatility is
less than 0.523
– small IB is an IB formation whose range in relation to volatility is
between 0.524 and 0.654
– large IB is an IB formation whose range in relation to volatility is
between 0.655 and 0.809
– very large IB is an IB formation whose range in relation to volatility is
greater than 0.81

Table 15.1. Relation of IB range to market volatility – short-term approach

IB range – ATR Percent of Total trades Profit Maximum Average trade Rate of return
relation winning drawdown
transactions

All IB 51.1% 28,647 $1,624,860 $-62,090 $57 2,617%

Very small IB 51.6% 7,157 $619,723 $-29,098 $87 2,130%
Small IB 51.2% 7,157 $345,495 $-33,156 $48 1,042%
Large IB 52.0% 7,158 $381,665 $-37,516 $53 1,017%
Very large IB 49.6% 7,156 $279,737 $-55,415 $39 505%

Discussion of results:

1. The best results were achieved by very small IB. In comparison with the
other groups, the most satisfactory results are: highest profit, lowest
drawdown, highest average trade, highest rate of return. Under the short-
term approach we thus achieved clear confirmation of the natural cycle of
volatility (periods of low volatility are interwoven with periods of intense
volatility), which Larry Williams wrote about in his book from 1999; the
subject has been taken up by many authors.
2. The weakest results in every dimension were recorded by the very large
IB. This comes as no surprise. After all, if IB has a large relation between
its size and market volatility (and thus does not represent declining
volatility, but rather stronger), the emergence of a breakout is naturally less
likely to succeed.
3. The two IB formations from the middle segments generate similar
results and are close to the performance of unfiltered IB formations. I treat
both categories as transitional forms between very small and very large IB.

Analysis of a medium-term approach

In the medium-term approach:

– very small IB is one whose range in relation to volatility is smaller
than 0.533
– small IB is one whose range in relation to volatility is between 0.533
and 0.66
– large IB is one whose range in relation to volatility is between 0.661
and 0.81
– very large IB is one whose range in relation to volatility is greater than
0.81

Table 15.2. Relation of IB range to market volatility – medium-term approach

IB range – ATR Percent of Total trades Profit Maximum Average trade Rate of return
relation winning drawdown
transactions

All IB 50.3% 18,234 $954,598 $-336,251 $52 284%

Very small IB 50.5% 6,048 $560,120 $-103,709 $93 540%
Small IB 49.9% 6,048 $269,600 $-172,766 $45 156%
Large IB 49.5% 6,048 $99,428 $-189,527 $16 53%
Very large IB 50.0% 6,048 $83,250 $-164,894 $14 51%

Discussion of results:

1. Again, the small IB works best out of all types of IB. Average profit is
over twice that of the profit of all other groups. The rate of return
compared to other categories also stands out.
 2. The second-best result for very large IB is a surprise. I am not able to
explain why this is. Let us wait and see the long-term results before
we address this matter.
3. Again, the two middle groups achieved similar results to each other,
but this time much worse than the results for all IB formations. The
average trade values of $16 and $14, respectively, after deducting
transaction costs provide a small profit just over the break-even level.

Analysis of a long-term approach

Under the long-term approach:

– very small IB is one whose range in relation to volatility is smaller

than 0.535
– small IB is one whose range in relation to volatility is between 0.536
and 0.659
– large IB is one whose range in relation to volatility is between 0.66
and 0.808
– very large IB is one whose range in relation to volatility is greater than
0.809

Table 15.2. Relation of IB range to market volatility – long-term approach

IB range – ATR Percent of Total trades Profit Maximum Average trade Rate of return
relation winning drawdown
transactions

All IB 50.7% 12,633 693,613 $-264,349 $55 262%

Very small IB 50.7% 5,229 386,765 $-147,875 $74 262%
Small IB 50.7% 5,229 393,614 $-230,372 $75 171%
Large IB 50.5% 5,229 163,874 $-198,831 $31 82%
Very large IB 48.8% 5,229 $-14,809 $-405,260 $-3 -4%

Discussion of results:

1. In the long-term approach we can find confirmation of the tendency

that emerged in the preceding two approaches. Indeed, it is clear that
the smallest IB formations function the best. Results weaken together
 with growth in the relation of the range of the inside bar to the
volatility present on the market. In the long-term approach, the very
large IB achieved negative returns, and the average trade was -$3.
Very small and small IB achieved results similar to each other, taking
first and second place.

RECOMMENDATIONS:

1. In all three approaches a clear tendency emerged: the smaller the

relation of the inside bar to the volatility on the market, the better the
results achieved. This tendency was disrupted only in the case of the
medium-term approach, when the very large IB was second-best in the
test. These surprising results, not supported by analyses from other
approaches, should be treated as an exception rather than the rule.
Remember that the best solutions are stable ones which perform
across multiple markets and time frames.
2. I must admit that I am fond of the concept of market volatility. I think
it can even be called my “market crush”. I understand it, I feel good
when using it, and I have many transaction conceptions based on it.
Aware of my subjective opinion on the subject, I would, however, like
to recommend it to everyone reading this book. I think it has
enormous potential that can be used in many different ways on the
market, not only in conjunction with IB formations.
 Chapter 16
Relation of the Size of the Inside Bar
to the Mother Bar

Volatility testing can also be approached in another manner. The dynamics

of price behavior are also determined by the relation between the sizes of
the bars comprising the IB formation. For example, when the range of both
bars is similar, volatility also remains steady. However, when the inside bar
is significantly smaller than the mother bar, we can assume that volatility is
declining, and the market “spring” is coiling.
Applying the above logic, I have categorized all IB formations into three
groups[11]:
a) Very small IB is a bar whose inside bar is less than 1/3 the size of the
mother bar. For example, if the range of the mother bar is 123 pips,
while the inside bar is 27.7 pips, the inside bar is 22.5% of the mother
bar (27.7 ÷ 123) – see Diagram 16.1.
b) Small IB is a bar whose inside bar is larger than 1/3 but smaller than
2/3 the size of the mother bar. For example, if the range of the mother
bar is 157.2 pips, while the inside bar is 96.5 pips, the inside bar is
61.3% of the mother bar (96.5 ÷ 157.2) – see Diagram 16.2.
c) Large IB is a bar whose inside bar is larger than 2/3 the size of the
mother bar. For example, if the range of the mother bar is 63.3 pips,
while the inside bar is 43.5 pips, the inside bar is 68.7% of the mother
bar (43.5 ÷ 63.3) – see Diagram 16.3.
Diagram 16.1. Very small IB
Diagram 16.2. Small IB
Diagram 16.3. Large IB

STATISTICAL ANALYSIS

Analysis of a short-term approach

Table 16.1. Classification of IB formations based on size of inside bar – short-term

approach
Relation of the size of the Percent of Total trades Profit Maximum Average Rate of
inside bar to the mother winning drawdown trade return
bar transactions
All IB 51.1% 28,647 $1,624,860 $-62,090 $57 2,617%
Small IB 51.0% 15,574 $808,814 $-44,041 $52 1,834%
Large IB 50.7% 10,441 $477,322 $-45,795 $46 1,042%
Very small IB 51.2% 1,792 $120,618 $-25 632 $67 470%

Discussion of results:
 1. Each type of IB formation generated positive results, which means
that this is a positive filter. It is, however, worth noting that none of
the groups generated a greater profit than the unfiltered IB.
2. Small IB generated the highest rate of return (1,834%), very close to
the rate of return of the unfiltered IB formations. This was the result of
a relatively small drawdown. While it is true that the large IB also
demonstrated a small drawdown, its profit was only $477,322
(compared to $1,620,000 for unfiltered IB).
3. Very small IB formations occur rarely. They constitute only 6.3% of
all formations. Their rarity, however, masks their high quality[12]. This
type of filter is distinguished by the highest level of percent of
winning transactions and average trade, which in conjunction with low
drawdown makes it possible to achieve a rate of return of 470%.
4. Surprisingly good results were also generated by large IB. In
comparison with other filters, it performs worse, but nevertheless at
a satisfactory level. Particularly worthy of attention is the high rate of
return (1,042%). However, worse performance is registered by the
other two parameters, percent of winning transactions and average
trade, both of which are worse than the parameters reached by
unfiltered IB and those from the remaining groups.

Analysis of a medium-term approach:

Table 16.2. Classification of IB formations based on size of inside bar – medium-term

approach
Relation of the size of the Percent of Total trades Profit Maximum Average Rate of
inside bar to the mother winning drawdown trade return
bar transactions
All IB 50.3% 18,234 $954,598 $-336,251 $52 284%
Very small IB 51.0% 1,679 $170,037 $-52,561 $101 323%
Small IB 49.3% 11,868 $533,052 $-210,367 $45 253%
Large IB 50.4% 8,636 $222,898 $-161,713 $26 138%

Discussion of results:

1. Each type of filter generates a positive rate of return.

 2. The most positive performer here is the very small IB. Not only did it
achieve a rate of return higher than the unfiltered IB, but it did so with
one-tenth of the transactions. In addition, the remaining parameters
(percent of winning transactions and average trade) are also very
positive. Particularly noteworthy is the average trade result, which is
20 times greater than the IB without the use of any filters. This
approach clearly demonstrates the advantage of very small formations.
3. Small IB also attained a very satisfying rate of return (253%), which
is a slightly worse result than that of the unfiltered IB. The level of
percent of winning transactions, however, disappoints, as it is the
lowest of all groups.
4. The results of large IB, while positive, are by far the weakest from
among all the groups. Rate of return disappoints, as does average
trade, which reaches a mere 50% of the same parameter generated by
unfiltered IB.

Analysis of a long-term approach

Table 16.3. Classification of IB formations based on size of inside bar – long-term

approach
Relation of the size of the Percent of Total trades Profit Maximum Average Rate of re-
inside bar to the mother winning drawdown trade turn
bar transactions
All IB 50.7% 12,633 $693,613 $-264,349 $55 262%
Very small IB 52.6% 1,590 $227,069 $-67,658 $143 336%
Small IB 49.6% 9,178 $346,404 $-405,451 $38 85%
Large IB 51.0% 7,123 $390,837 $-203,970$ $55 192%

Discussion of results:

Conclusions:
1. Each type of filter generates a positive rate of return.
2. As in the medium-term approach, very small IB is an exceptionally
attractive filter. Despite its rarity (only 12.6% of all IB formations), it
achieves by far the best results: highest rate of return – 336% (more
 than unfiltered IB), highest percent of winning transactions, and
highest average trade, which is 2.6 times larger than the unfiltered IB.
3. Small IB attained a modest 85% rate of return. Higher-than-average
drawdown and the lowest average trade and percent of winning
transactions make this filter clearly the least attractive in the long-term
approach.
4. The parameters achieved by large IB are comparable with those of
unfiltered formations. The rate of return generated by this filter is
lower, but was the result of far rarer forays into the market.

RECOMMENDATIONS:

1. Very small IB formations offer transactions of high quality in each of

the approaches employed. The one problem associated with the
smallest of the formations is the fact that they do not occur very often.
However, rather than concentrate on executing a large number of
transactions with average effectiveness, my experience has proven that
it is worth focusing on quality. The discussed filter can be applied as
a strong complementary filter, or even as a critical one used as the
basis for transaction conceptions. This approach should deliver much
better results.
2. Results of small and large IB are characterized by fluctuations
depending on the approach being tested. Such situations always lead
to questions about the stability of the analyzed filters. As a result, in
terms of these two groups I am not able to make a definitive
judgement.
 Chapter 17
Day of the Week

At first glance, it would seem that market conditions should be similar

regardless of the day of the week. In practice, however, something that
works on Mondays could be utterly ineffective on Wednesdays. One
explanation for this state of affairs is the schedule by which financial
events and indicators are published. As is well known, when important
reports and communiques are announced, the market is susceptible, to
a greater degree, to emotional investors (greater volatility), and emotions
are one of the primary drivers of strong price movements. It can,
therefore, turn out to be the case that Friday payrolls or Thursday interest
rates mean that during those particular sessions a breakout strategy will
generate better results than in others[13].
Another mechanism providing evidence of markets’ periodicity can be
observed on Mondays and Fridays. Monday is the beginning of the week
(of the weekly bar), and in my experience it has been the case that
a large number of movements begin during the first session, or the
second one at the latest; Friday is frequently the session during which
investors engage in profit-taking (a correction emerging when profitable
positions are closed). We will see on the following pages whether my
suspicions are correct.
At the beginning I tested all markets in aggregate. This approach to
analysis did not, however, lead to any concrete conclusions[14]. As it is,
every market has its own specificities and its own calendar of important
events. Thus, I decided to examine the influence of the day of the week
on particular sectors individually. Before we proceed to the analysis of
the data, I would like to clarify two important issues:
 a) In the tables below, when the IB (inside bar) has been assigned to
e.g. the group “Monday”, the trade based on it will take place on
Tuesday.
b) In my filters I have adopted another means of grouping the results
of the analyses. They are analyzed from the perspective of sectors
rather than transaction duration. I am convinced that in this specific
case it is a more logical way to proceed. Indeed, every sector has its
own specificities, and an analysis of all instruments taken together
could prevent us from being able to perceive the characteristics
typical for a given group of markets. For example, the famed payroll
reports have a large impact on the currency market, but a far more
limited one on the behavior of agricultural instruments.

Stock indexes sector

Table 17.1. Classification of IB formations by day of week. Short-term approach

Day of week Percent of Total trades Profit Maximum Average Rate of re-
winning drawdown trade turn
transactions
Monday 57.9% 1,360 $154,230 $-27,568 $113 559%
Tuesday 51.6% 947 $37,465 $-31,395 $40 119%
Wednesday 51.3% 1,008 $81,948 $-18,970 $81 432%
Thursday 55.8% 872 $84,740 $-21,090 $97 402%
Friday 48.0% 1,138 $-26,448 $-48,413 $-23 -55%

Table 17.2. Classification of IB formations by day of week. Medium-term approach

Day of week Percent of Total trades Profit Maximum Average Rate of re-
winning drawdown trade turn
transactions
Monday 53.1% 1,204 $173,253 $-74,583 $144 232%
Tuesday 48.1% 856 $-27,513 $-113,040 $-32 -24%
Wednesday 52.8% 898 $204,003 $-45,873 $227 445%
Thursday 47.6% 798 $-13,113 $-101,765 $-16 -13%
Friday 47.0% 1,014 $-267,328 $-288,283 $-264 -93%

Table 17.3. Classification of IB formations by day of week. Long-term approach

Day of week Percent of Total trades Profit Maximum Average Rate of re-
winning drawdown trade turn
transactions
Monday 54.6% 910 $113,120 $-71,408 $124 158%
Tuesday 48.9% 655 $-97,538 $-141,745 $-149 -69%
Wednesday 51.9% 711 $77,988 $-73,865 $110 106%
Thursday 50.7% 605 $87,143 $-81,868 $144 106%
Friday 47.1% 807 $-285,590 $-358,440 $-354 -80%

Discussion of results:

1. In the stock indexes the strongest days by far are Monday and
Wednesday. On these days, each approach generated exclusively
positive results. It is also worth pointing out that these results are
not only profitable, but they are clearly better than those generated
in the remaining sessions. This situation attests to the stability of the
observed dependency.
2. By far the weakest day of the week is Friday. The results generated
in every approach here are negative; in addition, this day was
always the worst in all the sessions. This situation also attests to the
stability of the observed dependency.
3. Tuesdays and Thursdays do not exhibit any strong tendencies. The
results generated on those days are sometimes positive, sometimes
negative.
4. One interesting observation is the evidently large disparity in
percent of winning transactions among days of the week (short-term
approach: 9.9%, medium-term: 5.7%, long-term: 7.5%) and in the
number of occurrences of the formation (the disparity between the
highest and the lowest day of the week was as high as 50%).

Currencies sector

Table 17.4. Classification of IB formations by day of week. Short-term approach

Day of week Percent of Total trades Profit Maximum Average Rate of re-
winning drawdown trade turn
transactions
Monday 50.0% 2,325 $38,960 $-48,535 $17 80%
Tuesday 46.3% 1,556 $-4,148 $-34,135 $-3 -12%
Wednesday 48.9% 1,618 $17,633 $-32,589 $11 54%
Thursday 46.8% 1,608 $-39,776 $-47,243 $-25 -84%
Friday 45.9% 1,705 $20,001 $-49,415 $12 41%

Table 17.5. Classification of IB formations by day of week. Medium-term approach

Day of week Percent of Total trades Profit Maximum Average Rate of re-
winning drawdown trade turn
transactions
Monday 46.6% 1,930 $-95,780 $-172,507 $-50 -56%
Tuesday 48.1% 1,395 $13,676 $-94,167 $10 15%
Wednesday 49.6% 1,445 $71,603 $-127,113 $50 56%
Thursday 49.7% 1,403 $1,304 $-102,184 $1 1%
Friday 50.4% 1,493 $79,709 $-76,136 $53 105%

Table 17.6. Classification of IB formations by day of week. Long-term approach

Day of week Percent of Total trades Profit Maximum Average Rate of re-
winning drawdown trade turn
transactions
Monday 44.2% 1,431 $-295,660 $-302,195 $-207 -98%
Tuesday 50.1% 1,107 $5,327 $-142,450 $5 4%
Wednesday 47.3% 1,129 $-33,241 $-162,199 $-29 -21%
Thursday 50.0% 1,100 $32,182 $-71,345 $29 45%
Friday 53.2% 1,142 $198,332 $-106,586 $174 186%

Discussion of results:

1. In the currencies sector, by far the strongest day of the week is

Friday – in each approach it generated results above 0. We should
also observe the fact that the rate of return in two of the approaches
was the highest among all days of the week. This attests to the
stability of the observed dependency. Somewhat surprising is that
this was achieved in spite of the fact that in the short-term approach,
the percent of winning transactions on Fridays is significantly lower
than in the remaining sessions.
2. On the other days of the week, the recorded results were similar to
one another but were unstable. The worst parameters were
 generated on Monday – in two of the approaches a negative rate of
return was generated, and only once was there a chance for profit.
However, none of the days were particularly weak, as, unlike the
case of the stock indexes sector, there were no days for which each
single approach generated negative rates of return.
3. In the currency sector we can also observe a large disparity in the
percent of winning transactions of particular days of the week: in
the long-term approach it is as high as 9%.

Metals sector

Table 17.7. Classification of IB formations by day of the week. Short-term approach

Day of week Percent of Total trades Profit Maximum Average Rate of re-
winning drawdown trade turn
transactions
Monday 55.9% 709 $153,938 $-24,815 $217 620%
Tuesday 46.1% 518 $-38,675 $-43,950 $-75 -88%
Wednesday 50.9% 582 $63,808 $-23,610 $110 270%
Thursday 49.9% 507 $79,608 $-31,985 $157 249%
Friday 54.6% 573 $97,155 $-28,100 $170 346%

Table 17.8. Classification of IB formations by day of the week. Medium-term approach

Day of week Percent of Total trades Profit Maximum Average Rate of re-
winning drawdown trade turn
transactions
Monday 48.9% 605 $29,053 $-150,813 $48 19%
Tuesday 50.8% 451 $7,345 $-134,375 $16 6%
Wednesday 48.4% 506 $-33,838 $-116,580 $-67 -29%
Thursday 42.4% 455 $-74,765 $-117,480 $-164 -64%
Friday 54.3% 495 $241,573 $-56,915 $488 424%

Table 17.9. Classification of IB formations by day of the week. Long-term approach

Day of week Percent of Total trades Profit Maximum Average Rate of re-
winning drawdown trade turn
transactions
Monday 48.0% 475 $-100,425 $-227,335 $-211 -44%
Tuesday 48.6% 358 $-123,688 $-220,625 $-345 -56%
Wednesday 51.7% 410 $22,348 $-138,863 $55 16%
Thursday 46.3% 352 $-16,028 $-146,765 $-46 -11%
Friday 59.5% 393 $263,633 $-71,320 $671 370%

Discussion of results:

1. In the metals sector the strongest day of the week is clearly Friday.
In every approach, this day saw exclusively positive results. It is
also worth noting the fact that the rate of return achieved in two of
the approaches was the highest among all sessions. The percent of
winning transactions is also very high and does not drop below
54%. This attests to the stability of the observed dependency.
2. The remaining days of the week present results similar to one
another: on Mondays and Wednesdays, positive results are achieved
in two of the approaches, while one of them generates negative
results; however, on Tuesdays and Thursdays one approach gives us
positive results, while the other two generate negative results. No
session recorded particularly weak results, meaning that in none of
them did all approaches lead to losses.
3. In this sector we can also observe large disparities in the percent of
winning transactions, which was as high as 13.2% in the long-term
approach.
4. Another interesting observation is that of the average trade in the
long-term approach on Friday, which was as high as $671. This
exceptional number grabbed my interest, so I took a closer look at
the statistics. It turned out that this good result was achieved by one
transaction that generated a profit of $60,000. When we observe
surprising data during an analysis of the markets, we should always
make an attempt at explaining it as it could be the result of
a mistake or, as in this case, of chance.

Agricultural sector

Table 17.10. Classification of IB formations by day of the week. Short-term approach

Day of week Percent of Total trades Profit Maximum Average Rate of re-
 winning drawdown trade turn
transactions
Monday 55.6% 1,630 $125,653 $-20,997 $77 548%
Tuesday 52.3% 2,052 $101,766 $-28,717 $50 354%
Wednesday 54.3% 2,035 $140,196 $-10,489 $69 1,337%
Thursday 52.7% 1,859 $97,233 $-19,088 $52 509%
Friday 53.1% 2,076 $158,283 $-14,887 $76 1,063%

Table 17.11. Classification of IB formations by day of the week. Medium-term approach

Day of week Percent of Total trades Profit Maximum Average Rate of re-
winning drawdown trade turn
transactions
Monday 51.5% 1,428 $103,520 $-50,853 $72 204%
Tuesday 51.8% 1,752 $138,327 $-45,780 $79 302%
Wednesday 52.6% 1,783 $235,382 $-29,769 $132 791%
Thursday 51.9% 1,629 $126,487 $-96,552 $78 131%
Friday 50.0% 1,794 $75,519 $-63,396 $42 119%

Table 17.12. Classification of IB formations by day of the week. Long-term approach

Day of week Percent of Total trades Profit Maximum Average Rate of re-
winning drawdown trade turn
transactions
Monday 51.3% 1,146 $83 $-117,714 $0 0%
Tuesday 52.5% 1,399 $187,556 $-51,792 $134 362%
Wednesday 51.8% 1,401 $265,222 $-45,402 $189 584%
Thursday 51.4% 1,318 $176,344 $-73,996 $134 238%
Friday 50.3% 1,420 $150,507 $-83,679 $106 180%

Discussion of results:

1. The agricultural sector is characterized by a positive stability not

encountered in any other sector. All days of the week generate
positive rates of return across all approaches (only on Monday, in
the long-term approach, was there a result just slightly above zero).
The positive performance of the entire sector means that the
application of this type of filter for agricultural commodities
instruments is rather senseless, as the best solution in that situation
is to conclude transactions during every session.
 2. It is also worth noting that no day of the week in any approach
generated percent of winning transactions below 50%. In the
previous sectors we were able to observe significant disparities in
the percent of winning transactions. Agricultural commodities,
however, exhibit very stable behavior, and the disparity does not
exceed 3.3%.
Energy sector

Table 17.13. Classification of IB formations by day of the week. Short-term approach

Day of week Percent of Total trades Profit Maximum Average Rate of re-
winning drawdown trade turn
transactions
Monday 56.0% 405 $55,126 $-58,459 $136 94%
Tuesday 49.8% 462 $16,118 $-39,311 $35 41%
Wednesday 52.3% 352 $27,711 $-23,202 $74 119%
Thursday 51.7% 373 $66,547 $-30,622 $179 218%
Friday 49.8% 492 $49,115 $-38,236 $100 129%

Table 17.14. Classification of IB formations by day of the week. Medium-term approach

Day of week Percent of Total trades Profit Maximum Average Rate of re-
winning drawdown trade turn
transactions
Monday 47.4% 359 $-3,800 $-100,416 $-11 -4%
Tuesday 53.8% 416 $109,979 $-89,557 $264 123%
Wednesday 53.9% 321 $-10,050 $-79,408 $-31 -13%
Thursday 55.2% 337 $163,456 $-45,935 $485 356%
Friday 49.8% 424 $66,069 $-80,639 $156 82%

Table 17.15. Classification of IB formations by day of the week. Long-term approach

Day of week Percent of Total trades Profit Maximum Average Rate of re-
winning drawdown trade turn
transactions
Monday 53.7% 300 $96,787 $-116,094 $323 83%
Tuesday 50.5% 323 $-8,834 $-104,923 $-27 -8%
Wednesday 53.5% 260 $83,042 $-142,046 $319 59%
Thursday 55.4% 269 $242,618 $-86,186 $902 282%
Friday 50.3% 350 $96,104 $-162,343 $275 59%
Discussion of results:

1. In the energy sector, by far the strongest days of the week are
Thursday and Friday – in each approach they generated exclusively
positive results. It should also be noted that the rate of return
achieved for each Thursday is the highest among all days of the
week.
2. The remaining days of the week generate similar results: Mondays,
Tuesdays, and Wednesdays give positive results in two approaches
and negative results in one. No day of the week generates
particularly poor results, that is, in no approach do they generate
solely losses.
3. One interesting thing is the exceptionally low disparity in the
number of IB formations across days of the week. In this respect the
sector behaves with exceptional stability.
4. Another interesting observation regards the average trade value in
the long-term approach on Thursdays, which is as high as $902.
This result was not generated by a single transaction as in the case
of metals. Nevertheless, this result should be approached with some
caution as it was generated on the basis of 269 transactions, which
amounts to only 26 transactions a year. Additionally, we should be
aware of the possibility that we are dealing with over-optimization.
The week filter in our test is, in reality, a combination of two filters:
sector and day of the week.

Financial markets sector

Table 17.16. Classification of IB formations by day of the week. Short-term approach

Day of week Percent of Total trades Profit Maximum Average Rate of re-
winning drawdown trade turn
transactions
Monday 47.0% 1,126 $58,806 $-10,557 $52 557%
Tuesday 46.6% 655 $-4,784 $-19,380 $-7 -25%
Wednesday 46.9% 667 $15,917 $-9,248 $24 172%
Thursday 48.8% 701 $32,035 $-11,058 $46 290%
Friday 36.1% 599 $-31,413 $-33,474 $-52 -94%

Table 17.17. Classification of IB formations by day of the week. Medium-term approach

Day of week Percent of Total trades Profit Maximum Average Rate of re-
winning drawdown trade turn
transactions
Monday 53.3% 915 $98,377 $-28,704 $108 343%
Tuesday 45.6% 577 $-46,571 $-58,758 $-81 -79%
Wednesday 50.7% 564 $12,983 $-37,126 $23 35%
Thursday 47.6% 618 $6,944 $-54,420 $11 13%
Friday 45.5% 523 $-65,444 $-71,986 $-125 -91%

Table 17.18. Classification of IB formations by day of the week. Long-term approach

Day of week Percent of Total trades Profit Maximum Average Rate of re-
winning drawdown trade turn
transactions
Monday 53.0% 674 $64,673 $-45,268 $96 143%
Tuesday 45.0% 453 $-31,118 $-62,788 $-69 -50%
Wednesday 45.2% 427 $-65,610 $-82,172 $-154 -80%
Thursday 49.5% 479 $64,961 $-42,931 $136 151%
Friday 42.0% 436 $-134,798 $-146,625 $-309 -92%

Discussion of results:

1. The financial sector generates what are by far the most unstable
results, which makes application of the day of the week filter more
than justified.
2. Two days – Monday and Thursday – generated positive rates of
return in all approaches. It is worth noting the fact that these results
are not only positive, but also clearly better than those generated in
the remaining sessions. This attests to the stability of the observed
dependency.
3. Tuesday and Friday consistently generated losses. Friday was
a particularly poor performer. Not only were the results generated
that day negative, but in case approach the rate of return achieved
was by far the lowest among all IB groups. This attests to the
stability of this negative dependency.
 4. Of interest is the exceptionally large disparity in the value of some
parameters: percent of winning transactions, total trades, rate of
return, and average trade.
5. It is also worth noting the fact that the percent of winning
transactions on Friday in the short-term approach achieved the
lowest value – a mere 36.1%.

RECOMMENDATIONS:

1. First and foremost, I recommend caution in drawing conclusions on

the basis of this filter. If we apply two filters at the same time (first
the market sector filter, and then analyzing certain days of the
week), the number of transactions taken into consideration in the
statistics falls drastically, which increases the risk of over-
optimization. This is why before deciding to use a particular filter,
we should make sure that the results it generates are not the work of
chance.
2. In the stock indexes sector, I recommend ignoring IB formations
that emerge on Fridays (negative filter) – in each approach the
results generated during the last session of the week were negative.
3. In the agricultural sector I recommend concluding transactions on
the basis of IB formations every day of the week. These instruments
behaved with exceptional stability.
4. I also recommend ignoring IB formations in the financial markets
sector on Fridays (negative filter) – in each approach the results
generated during the last session of the week were negative.
 Chapter 18
The General Context in which
Inside Bar Formations Emerge

An IB can be an independent formation, but it can also be part of another,

larger multiple candlestick formation. In this chapter I will analyze the
consequences that result from the combination of an IB with these types of
patterns. Because multiple candlestick formations that emerge over
a number of days are difficult to translate into the language of mathematics
(and at the same time it is difficult to obtain definitive confirmation or
negation of the effectiveness of a given tool, as was the case with filters),
this information will be the result of my observations based on years of
experience in speculation. Here it should also be added that the number of
multiple candlestick patterns described in the investment literature[15] is
incredibly large. For obvious reasons I am not able to analyze even a small
portion of them. Below I present only those multiple candlestick patterns
that I use profitably in my trading, and which I recommend my readers to
apply. However, I do encourage you to do your own testing and analyze the
link between IB and other patterns on the chart, such as with indicators,
wave analysis, trend lines, or trend channels. How can we conduct this
type of analysis?
We need to carry out two tests. The first of them is a test of the
effectiveness of a multiple candlestick formation without the appearance of
an IB, while the second would include an IB. Next, the results should be
compared. Improvement of results should be noticeable in the form of both
higher expected value from such a trading plan, and better results from one
of the key parameters in the system, such as percent of winning
transactions or risk/reward ratio. Let us remember that when analyzing
results, we cannot only look at a comparison of the profit from the two
systems. Adding an additional filter to our initial strategy always leads to
a reduction in the number of signals – in effect, profit may decline, but
since we are entering the market more rarely but at better moments the
remaining signals may turn out to be higher quality (higher average trade
value), which will lead to shallower drawdowns and easier trading.
It is worth reviewing multiple candlestick patterns and IB formations
jointly, as they exert a mutual influence on each other. This is justified in
spite of the fact that an IB is a two-candlestick formation with a short-term
predictive value, while multiple candlestick formations (such as head-and-
shoulders – H&S) are patterns which exert an impact on the market long
after their formation. At times a multiple candlestick formation impacts IB,
boosting its market advantage or potential range of movement, which
begins at the same time as its breakout; at other times, IB improves the
results achieved in larger formations, such as by reducing the size of stop-
loss and improving the risk/reward ratio of a given chart pattern.
In this chapter we will analyze connections of IB with selected
formations created by Joe Ross, such as: 1-2-3, Traders Trick Entry (TTE),
ledge, as well as the popular H&S formation and support and resistance
levels.

1-2-3 HIGHS AND LOWS

The 1-2-3 formation can appear in both a pro-downtrend version (1-2-3

high) and a pro-uptrend version (1-2-3 low). In this book I present the
downtrend version. The uptrend version is its mirror image.
The 1-2-3- high reverses an uptrend, turning it into a downtrend. It
emerges at the end of a given up-move when the price creates the highest
high in an existing trend. The high emerges when the bars on the right and
left side have a lower high than the bar between them[16] (see Diagram
18.1; the high is marked with a ‘1’). When analyzing 1-2-3 highs and lows,
but also in reference to any other market formation, it is important to be
aware of the mechanisms which determine whether the price rises or falls
at a given moment. The price is trending up to point 1 because the buyers
are determined enough and sufficiently convinced of the undervaluation of
the given instrument that they are placing buy orders (primarily market and
stop), which are executed, from their perspective, at worse (higher) prices.

Diagram 18.1. Formation of point 1 in a 1-2-3 high

Buyers decide to take this step because they want to be certain that they
will succeed in executing their trade, and they are concerned that the
market might start heading upward without them. It is precisely this
determination and readiness to place orders at “worse” prices that leads to
price increase of a given instrument. At a certain moment, the resolve of
the buyers begins to soften. They cease aggressively accumulating a given
product. Other buyers stop believing in further up-moves, so they take their
profits (placing sell orders to close long positions). Still another group of
investors expects a sudden selloff, and places orders opening short
positions. The cumulative activity of all the investors leads to the
occurrence of a correction.
The selloff lasts until point 2 (Diagram 18.2). This place is also created
as a result of the activities of several groups of investors at once. A portion
of them are traders who see a strong uptrend, and regard the present selloff
as an opportunity to join in the upward movement. Another driving force
can be institutions which began opening short positions at point 1, and
again wish to push for higher prices in order to expand their holdings (for
large investment firms, because of the volume they generate, opening and
closing transactions is a long-term and multi-phase process). It is possible
that orders at point 2 also come from traders with a short time horizon,
who are placing buy orders to close their profitable short positions opened
around point 1. Point 2 is confirmed when the next bar achieves a low
higher than the low of bar 2, while the high of bar 2 will be violated within
the next three successive bars following its formation. This breakout is the
commencement of a movement towards point 3 of the formation.

Diagram 18.2. Formation of point 2 in a 1-2-3 high

Diagram 18.3. Complete 1-2-3 high and low

At point 3 the buyers again come to the fore (Diagram 18.3). The traders
who get into the action (including institutions which did not open
satisfactorily large positions) are those who think that the upswing has
finished. They place orders below the high of point 1 because they are
afraid the price will not touch its previous high, and the selloff will begin
without them present. As a result of their actions, the price drops. If their
sale orders dominate buy orders, and the low of bar 3 is violated within the
three following bars, we will be witnesses to a progressing selloff and the
complete emergence of a 1-2-3 high[17]. However, if the buy orders turn
out to be stronger and the price begins trending upward, breaking out
above bar 1, the entire formation will be negated (Diagram 18.4).
Point 3 is confirmed as the next bar has a high located below the high of
bar 3, while the low of bar 3 is broken out within the next three bars after
its formation. This breakout is equivalent to taking a short position.
Diagram 18.4. Negation of 1-2-3 pattern

Joe Ross allows for a certain amount of freedom in the shape of a 1-2-3
pattern. For experienced traders, certainly a more subjective assessment of
the formation can deliver some benefits. However, for beginners the
absence of clear tips regarding the conditions for the development of
a pattern can cause heavy damage. Freedom in the shape of a given
formation means that investors frequently perceive formations where they
are not really present and enter into poor-quality transactions. It is
precisely with less experienced traders in mind I instruct my seminar
participants that bars between points 1 and 2, as 2 and 3 should align in
a proper up or down sequence (depending on the direction of a given
segment). For example, in a 1-2-3 high, the segment between points 1 and
2 is a downtrend one, so the next bars should display increasingly lower
highs and lows. The segment between points 2 and 3 of the same patterns,
however, is an uptrend one, thus successive bars should be characterized
by a series of higher lows and highs, until point 3 is confirmed. The
exception is only the IB which joins to the bar created before it – in fact, it
does not impact the 1-2-3 pattern (unless its breakout also denotes point 3).
Diagram 18.5. Example variants of 1-2-3 pattern[18]

To summarize, every 1-2-3 high[19] should meet the following critical

conditions:
1. The market is dominated by an uptrend.
2. The high of the bar 1 is higher than the high of the bar located to its
immediate left and immediate right, while the highest high in the
previous upward movement is denoted precisely by point 1.
3. Point 2 is the first swing low immediately after point 1. Its low is
lower than the low of the bar located directly at its left and right side.
4. Confirmation of point 2 must occur within not more than three bars;
this confirmation is a bar or combination of bars violating the high of
point 2.
5. Point 3 is the first swing high emerging immediately after point 2.
Point 3 reaches a higher high than the high of the bars located to its
immediate left and right.
6. Confirmation of point 3 must come within not more than three bars;
confirmation is a bar or combination of bars violating the low of point
3.
7. The distance between points 1, 2, and 3 is irrelevant.

IB TOGETHER WITH A 1-2-3 PATTERN

Let us take a look now at what is the most important thing for us: the
connection of a 1-2-3 pattern with an IB formation. For this union to have
the desired value, the IB should occur at the last stage of the creation of
a multiple candlestick formation – that is, after the emergence of point 3. In
Diagram 18.6, version A presents a 1-2-3 high without IB, while version B
presents the same 1-2-3 high with IB. In both situations the transaction
entry levels are marked, as well as the most common stop-loss levels. How
has the IB in the 1-2-3 pattern strengthened our signal?
When a normal 1-2-3 pattern has developed, it was possible to take
a short position only with the breakout of the low of the bar denoted by the
number 3. However, when an IB has appeared at the end of a 1-2-3 pattern,
we could take a short position sooner, that is at the breakout of the low of
the formation’s inside bar.
Besides joining a new movement sooner, IB also allows us to set
a narrower stop-loss. IB formations are frequently bars with a smaller
range than the average. In respect of version A, the closest sensible stop-
loss is the opposite side of bar 3. However, when an IB appears at the end
of a 1-2-3 pattern, the natural location for setting a protective order is the
opposite side of the inside bar. Significantly reducing the size of the stop-
loss will improve the relation of risk to reward in every trading strategy.

Diagram 18.6. Difference in taking a position based on a 1-2-3 pattern without IB (A) and
with IB (B)

During the formation of an IB, the market is “compressed”. Previously,

I compared this situation to a spring. If we enter the market at a moment of
low volatility, we have logical grounds for expecting that volatility will
soon increase. When this happens at the moment of the breakout of an IB
and at the same time of our entry into transactions based on the
confirmation of point 3 in the 1-2-3 pattern, we can expect that the market
from our opening level will rapidly shoot up, quickly making our new
transaction profitable. From the perspective of psychology and transaction
management this fact is of no small importance.

Diagram 18.7. Sample transaction opened on the basis of a 1-2-3 pattern and IB (no. 1.)
Diagram 18.8. Sample transaction opened on the basis of a 1-2-3 pattern and IB (no. 2.)

The connection of the two concepts also gives us one more benefit. By
its nature an IB formation influences the market within the next few bars.
A 1-2-3 pattern, however, has a more long-term effect. Thus, adding a 1-2-
3 pattern to an IB allows traders to remain longer in profitable trades if
they opened their positions based on a breakout of the IB. If the
momentum was first realized as a result of the breakout of an IB, it is likely
that this dynamic movement will continue as the result of actions by
investors who have contributed to the development of a larger pattern, that
is, a 1-2-3 highs or lows.
The 1-2-3 and IB formations are complimentary. In short, it can be said
that the former allows the trader to remain in the market longer, while the
latter allows the trader to achieve a better risk/reward ratio. This looks like
a true market synthesis!
 In Diagrams 18.7 and 18.8 I have presented example transactions based
on a 1-2-3 pattern and IB formation.

TRADERS TRICK ENTRY

The TTE (Traders Trick Entry) is another pattern described by Joe Ross.
This one can be used consistently only in the direction of the prevalent
trend. This makes it a different type of pattern than the 1-2-3 highs and
lows, which announced the coming end of a given price movement.
If we wish to use TTE in our own trading, the first step is to identify the
trend. Joe Ross suggests that a TTE always be preceded by a 1-2-3 pattern.
This is a certain strategy, but I personally prefer a more universal approach.
It is enough for me when a TTE appears within a trend identified using any
logical method. This could be a 1-2-3 pattern, moving average, or some
other tool. For the purposes of this book, we will adopt the methodology
proposed by Joe Ross.
Diagram 18.9 shows us a clear uptrend. It is developing as a result of the
same behaviors on the part of investors that I presented in our discussion of
the 1-2-3 pattern. Yet at a certain moment the determined bulls begin to
lose their confidence and begin profit-taking; the chart shows the
emergence of a swing high which denotes the current high of the given
price movement, after which the market briefly stops rising. This moment
could be the beginning of a 1-2-3 high or TTE. At this point in our analysis
we still do not know. We can determine the more likely scenario with the
help of other tools, or a chart with a higher time frame.
Diagram 18.9. First stage in the development of a TTE

When the price begins to fall as a result of increasingly aggressive sale

orders coming in (bulls closing their positions and bears opening short
positions), a correction is beginning in the market. At a certain moment,
however, the brakes are put on by traders expecting the continuation of the
uptrend (the investor’s behavior continues to follow that of the 1-2-3
pattern). The TTE trade consists in an entry at the breakout of the high of
the bar halting the corrective movement (Diagram 18.10) in the
expectation that the upward movement will indicates continuation of the
general trend. A critical factor in this situation is the fact that opening
a position should occur not later than the breakout of the third bar
constituting the correction. The deeper and longer in duration the
correction, the less likely that the trend will be continued. In Diagram
18.11 I have included three variants of this formation. The TTE short
variants are exactly the opposite in appearance.
Diagram 18.10. Second stage in the development of a TTE

Diagram 18.11. Three variants of TTE: TTE 1 (A), TTE 2 (B), TTE 3 (C)

IB TOGETHER WITH TTE

The idea of linking TTE with IB is very similar to that of the 1-2-3 pattern.
In Diagram 18.12 I have presented a TTE in conjunction with IB along
with transaction opening levels and the most natural level for a stop-loss
order. As before, the combination of the two formations brings us four
primary benefits:
1. Opening our position sooner, which results in more space to the
previous high and, by the same token, greater potential for profit.
2. The possibility of setting a smaller stop-loss at the low of the inside
bar (not at the bottom of the entire correction), which improves the
risk/reward ratio for a given transaction.
3. Quicker profit turned by the position, which is possible owing to
a breakout from a consolidated market (IB is a form of consolidation).
4. Increased potential for profit. TTE is a pattern with a longer influence
over the market than an IB formation. As a result, entering the market
on the basis of the breakout of an inside bar we can keep open our
profitable position longer than we would be able to in the case of
a two-bar formation.

Diagram 18.12. Connection of IB and TTE

In diagrams 18.13 and 18.14 I have presented example transactions

based on TTE and IB formation.
Diagram 18.13. Sample transaction opened on basis of TTE and IB formation (no. 1)
Diagram 18.14 Sample transaction opened on basis of TTE and IB formation (no. 2)

TRADING RANGE

Trading ranges are frequently described in the investment literature. Joe

Ross, in his book Day Trading, provides descriptions of several types of
trading range. The popularity of patterns representing a balance of power
between bulls and bears results from the fact that for the majority of the
time, the market price is in neither in an up or downtrend, but rather in
a sideways trend.
My experiences with trading ranges from the beginning of my career
were quite painful. Trading on breakouts from horizontal movements,
I frequently experienced how the final, real breakout was preceded by
a number of false ones, after which the price returned to its previous level
and caused me to lose money. A series of these losing transactions
frequently proved discouraging enough that when the price finally “took
off”, I was so emotionally and financially exhausted that I could not open
any more transactions in spite of the fact that the final one would make
a profit. I can imagine that the majority of traders have had similar
experiences. In order to better understand the difficulties associated with
investing when the price is moving horizontally, let us analyze Diagram
18.15.
First, we have to define the concept of trading range. In my own trading
I define trading range as a situation in which the price is located between
two swing highs[20] at one level, and two swing lows at another[21]. In
Diagram 18.15 I have highlighted the moment where I would conclude that
the market is in a horizontal trend. I would also like to draw attention to the
fact that when designating a trading range, swing highs and lows are not
necessarily identical with the extreme values of a consolidation. For
example, between the bars in Diagram 18.15 denoting the upper limit of
the trading range the market broke out 1 tick higher than the previous top,
which I accept.
Another important issue in my trading during a consolidation is avoiding
updating levels denoting a trading range in the course of a developing
chart. False breakouts do not change its borders. The trading range will
finish when one bar is located entirely outside the appointed limits.
Diagram 18.15. Trading range

Returning to chart 18.15 and difficulties in trading during horizontal

trends, I would like us to turn our attention to the number of false
breakouts after which the market returned to the interior of the trading
range. I have marked four of them on the chart. Later, consistent with the
adopted criteria, the trading range completes; nevertheless, the market did
not move in any direction, and again turned upward, twice testing the
original border of the consolidation. Well, the market is not perfect and no
definition will ever work in all situations, but this does not mean that
traders should avoid employing trading assumptions that are intended to
help maintain discipline and self-control.
The issue of false breakouts does not only concern unsuccessful attempts
at initiating a trend, but also the placement of potential stop-losses. As we
can see in the presented example, the protective orders in the middle of the
consolidation or on its opposite side are not sufficient to safely wait out the
period of market stasis. It is this very consideration that led me to start
seeking a way of effectively trading consolidations.

IB TOGETHER WITH TRADING RANGE

The strategy below is one I employ on the S&P 500 at the 1-minute time
frame. It is possible to apply this approach in other time horizons as well,
but I personally have not done such tests. Nevertheless, if someone wants
to examine the effectiveness of the connection of IB with trading range on
other charts, they should properly adjust the parameter of the size of the
inside bar.
At the moment when a trading range is forming in the market (Diagram
18.16), I look closely and observe whether an IB begins soon after. I am
expecting a very small IB formation, which on a 1-minute chart means an
inside bar of 1 tick. Let us recall the test of particular filters, from which
we learned that small IB is characterized by greater effectiveness and helps
us attain a better risk/reward ratio in our transaction. When the expected IB
emerges, I place two orders on the market that are linked to each other, for
the breakout of both the high and low of the inside bar. The execution of
one order automatically cancels the opposite order. In applying this
approach, we must remember that:
1. The direction of the breakout of the IB is irrelevant.
2. IB can appear at any moment inside the trading range (I personally
prefer when the IB forms at the edge of a trading range, and the
breakout moves price to the inside of the horizontal movement – the
space up to the top border of the trading range gives me a strong
feeling of safety – but this kind of pattern is not a necessary
precondition.
Diagram 18.16. IB together with trading range

3. In order to save 1 tick (which in the case of a 1-minute time frame can
significantly improve results), the level for order activation should be
set at 1 tick above or below the IB, however the level for limit-order
execution is set to the high or low of the signal bar.
As we can see in the example, the market has broken out in an uptrend,
and a long position has been opened. The transaction was taken at a price
of $1882.50, while the stop-loss was set at the other side of the formation
at a level of $1881.75 (a risk was only 3 ticks). Below I describe how in
this case the IB and trading range are mutually complementary.
1. Trading on a breakout of the IB, we are anticipating a breakout from
the trading range. By the same token, in opening a long position (as
we can see on Diagram 18.16), we expected that the price would soon
test the upper extreme of the trading range. However, if the test was
a failure, our previous profit would still be so large as to make closing
 the transaction at a loss unlikely[22]. A similar situation would be the
case if the breakout were downward. Indeed, the advantage resulting
from the profit achieved before the price reached the bottom of the
trading range would be significantly smaller, but on a 1-minute chart
saving even one tick on an individual transaction is worth the effort.
2. Trading on a breakout from a trading range, it can be difficult to set
the appropriate stop-loss. The formation of a small IB significantly
reduces the risk incurred. In this manner, maintaining the original size
of the position, we can incur several small losses before the ultimate
breakout from the trading range takes place and generates the desired
profit. Additionally, in applying a very small stop-loss, the risk/reward
ratio is significantly improved.
3. The range of the trading range breakout is most frequently determined
by using the height of the consolidation (which we measure from the
breakout level). The connection with an IB offering a small stop-loss
together with the potential profit that is derived from the large
formation leads to a very beneficial risk/reward ratio for a given
transaction (in some transactions as much as 10 to 1).
4. In the course of formation of an IB in trading range the market is
experiencing a sort of double “tension”. A trading range is a formation
in which the market naturally slows down, and volatility decreases.
When an IB forms, this volatility declines even more. Always when
entering the market at moments of low volatility, we have logical
grounds to conclude that volatility will soon increase. When this
happens at the moment of an IB breakout, and a moment later we see
a breakout from the trading range, we are benefiting from a sort of
double momentum.
In Diagrams 18.17 and 18.18 I have presented example transactions
based on a trading range and an IB.
Diagram 18.17. Sample transaction opened on the basis of a trading range and IB (no. 1)
Diagram 18.18. Sample transaction opened on the basis of a trading range and IB (no. 2)

HUNTING STOP-LOSS ORDERS

Another market situation, which is an excellent partner for the IB

formation, is the so-called “stop-loss hunting”. Stop-loss hunting is
perhaps not a formation per se, but the location of an IB in a specific place
on the chart which definitely offers significant improvement to the
reliability of a two-bar formation.
Stop-loss hunting is a situation in which larger traders use the stop
orders of smaller investors (who are frequently less experienced) to
execute their large orders (entering or exiting the market). This situation is
presented in Diagram 18.19. In practice I only employ stop-loss hunting in
the direction of the trend. For example, in the case of an uptrend, I seek
stop-loss hunting at the bottom of the emerging downward correction,
whereas in the case of a downtrend I am interested in the behavior of the
price at previous highs. I never use the concept of stop-loss hunting in
a direction contrary to the tendency dominating the market at a given time.
The first step in concluding transactions based on stop-loss hunting is
defining the trend. To do this, I generally use the simple tool of the moving
average for 200 sessions (Diagram 18.20). After the emergence of the
highest high in the current trend, a downward correction begins. During
this correction we can observe stop-loss hunting where we could open
a transaction (the market would give a signal of the correction’s end). This
type of opportunity is depicted in Diagram 18.21.
If we analyze the entire downward movement from the swing high, we
will observe that we have encountered three instances of stop-loss hunting.
The first two did not lead to a reversal of the price[23], but (what is worth
noting) at their level there was no reliable bar that could be viewed as
a predictor of the reversal of the current trend. Such a situation occurred
only after the third stop-loss hunting, where an IB formed at the level of
the preceding low. At the level of this stop-loss hunting were the following
orders:
Diagram 18.19. Sample stop-loss hunting levels
Diagram 18.20. Sample stop-loss hunting situation
Diagram 18.21 Example stop-loss hunting situation

– Stop-loss orders of small investors who, in hope of a return of the

uptrend, opened positions after the development of the reversal bar, at
the same time setting their protective orders under its low, and
– buy limit orders of large investors who needed the orders of small
investors in order to open long positions in accordance with the trend
over a higher time frame. Large investors were the other side of the
transaction for sale orders under the previous low

IB TOGETHER WITH STOP-LOSS HUNTING

In Diagram 18.22 I have presented the connection of an IB formation with

stop-loss hunting. As we can see, the price has held at the level of the
previous low and is beginning to create an IB formation, followed by
a double IB. This hesitation attests to the fact that the lower prices were
rejected by larger investors. Opening a long transaction should be executed
at the breakout of the most inside bar. This situation is very reliable and
gives us an exceptional opportunity to combine IB, trend strength, and
stop-loss hunting. The advantages we obtain owing to the combination of
all three elements are:
1. A short stop which results from the nature of IB and allows for a very
good risk/reward ratio.

Diagram 18.22. Combination of stop-loss hunting and IB

2. The connection of the strength of the IB breakout, which allows for

the price to quickly depart from entering market level, which also
gives us far greater comfort during management of the transaction.
3. The phenomenon of stop-loss hunting (which I use exclusively in the
direction of the trend) has far greater earning potential, which allows
for us to keep a profitable transaction opened on the breakout from the
IB going longer. In situations where we open a transaction at the
 bottom of a correction, the first levels of profit-taking would be the
previous swing highs, and then the highest high in the current uptrend.
Additionally, we can manage the transaction in the trend-following
way and attempt to achieve even greater profit.
In Diagram 18.23 I have presented other examples of transactions based
on stop-loss hunting and IB.

Diagram 18.23. Transaction opened on the basis of stop-loss hunting and IB

HEAD-AND-SHOULDERS FORMATION (H&S)

The next formation I will present is the classic version of the head-and-
shoulders pattern. I have taken the description most commonly
encountered in the literature and added a few conditions which allow me to
select patterns with a greater chance of success, and which are better suited
to my trading needs and style. Without any additional assumptions,
I always had a problem with the subjective determination of whether
a given market pattern is H&S or not. In order to avoid the trap of “almost
a formation”, I have attempted to compose a definitive description of the
formation: H&S is comprised of three highs and two lows between them,
and:

Diagram 18.24 Examples of highs in an H&S formation

a) a high (denoted by the number 3 on Diagram 18.24) occurs when it

has a higher high than the high of the two bars at the left (bars 1 and
2) and the two bars at the right (bars 4 and 5) while the relation
between bars 1 and 2[24] and 4 and 5 is irrelevant;
b) a low (denoted by the number 3 on Diagram 18.25) occurs when it
has a lower low than the low of the two bars at the left (bars 1 and 2)
and the two bars at the right (bars 4 and 5) while the relation between
bars 1 and 2 and 4 and 5 is irrelevant.
The H&S formation is a reversal pattern (similar to 1-2-3) and should
occur at the top of an uptrend. It is characterized by a high level of
effectiveness, which most likely is the result of its popularity; in turn, this
makes a large number of traders prone to trading on its development
following the same pattern. This is, of course, my intuition. In reality, in
order to make money you do not need to understand the causes of a given
state of affairs, but rather the effects of it.

Diagram 18.25. Sample of low in an H&S formation

The conception for determining highs and lows, which is different from
in the case of the 1-2-3 pattern, is the product of my experience and beliefs.
I have adopted the method presented above from Larry Williams, and as
I have come to learn, the highs and lows determined in this way are more
reliable. I do not employ them in 1-2-3, because this is an original pattern
by Joe Ross, and I honestly do not know how such a change in his
formation would impact the results attained. The proper shape of my H&S
formation is presented in Diagram 18.26.

Diagram 18.26. An H&S formation

IB TOGETHER WITH H&S FORMATION

In the case of a classic formation, the opening of the position is concurrent

with the breakout of the neckline. However, I open my transaction sooner,
in anticipation of the emergence of the right shoulder of the formation
where dynamic movement resulting from the pattern is just beginning. In
order to enter the market sooner, I make use of an IB formation.
Diagram 18.27. Connection of H&S formation with IB

In Diagram 18.27 I have presented an example of a transaction involving

an inverse H&S. We can see how an IB came into being during the
formation of the right low. In accordance with the definition adopted
earlier, we could open our position only after the close of the second bar,
starting from the potential swing low. In this case, however, after the
initiation of the IB, it is possible to open our position sooner. According to
statistics, only 10% of bars on the market are outside bars. We can thus
assume that our anticipation of the creation of a second bar whose low will
be above the lowest low should prove correct in 90% of cases. In my
career of over 10 years I cannot recall a single situation where this logic
has failed me.
Benefits from combining IB and H&S formations:
1. In this case, IB serves me as a signal bar. I do not trade H&S patterns
when an IB does not emerge. Waiting for the formation of two bars
after the appearance of the high/low of the right shoulder would lead
 with high frequency to a significant portion of potential profit being
eaten up before we managed to enter the market.
2. The small stop-loss that results from the nature of the IB, along with
the relatively large potential for profit determined on the basis of H&S
pattern, means that in transactions combining the benefits of the two
formations we can achieve a high risk/reward ratio.
3. Opening a transaction on an IB, which I wrote about earlier, always
allows us to expect that the new position will quickly make a profit,
which makes managing it easier. Diagram 18.28 depicts an example of
a transaction combining H&S and an IB formation.

Diagram 18.28. Transaction opened on the basis of an H&S pattern and IB

GAP

A market situation I frequently take advantage of is the gap. There is

a large number of publications devoted to this subject. Below I describe
a specific type of gap, along with one of the ways I conclude transactions
using it.
In my own trading I focus on gaps generated between successive
sessions[25], which open up outside the extremes of the previous day’s
session (uptrend gaps which open beyond the maximum of the preceding
day, or downtrend gaps which are beyond the low of the preceding day).
Examples of such gaps can be found in Diagram 18.29.
These types of gaps can be observed when we are dealing with markets
that are not in operation 24 hours a day[26], or when analyzing RTH
(Regular Trading Hours).

Diagram 18.29. Gaps on a daily chart

An example of an instrument whose price fluctuates through the entire day

(via an electronic market), while sessions are regularly much shorter and
match the market’s opening hours, are futures contracts on the S&P 500.
When we focus exclusively on the chart resulting from the so-called
regular session, that is the period from the official opening of the market
session until its close, we can easily observe these gaps which regularly
emerge between sessions. However, for me to open a transaction on such
a gap, it has to fulfill some additional conditions. They are:
1. The gap has to form at the top of an uptrend[27], and its open should
take place above the highest price noted in the preceding 30 days. The
mechanism responsible for the effectiveness of this pattern consists in
the expectations of small traders at the breakout of price highs that the
uptrend will continue to develop, so they quickly pile on to the trend.
Large traders, however, take the opposite approach. They want to join
the movement, but at a better price. Therefore, they refrain from
strengthening the movement with their orders, as a result of which the
market begins to run out of buyers after a moment, and the price
enters into a correction. It is at this point, at the bottom, that the large
traders join the trend, if they feel it is warranted.
2. This strategy was created exclusively for the S&P 500. Every market
is different. The S&P 500 is characterized by the fact that breakouts
heading upwards are frequently faded. Downtrend breakouts – not as
much, because under the swing lows investors frequently set stop-loss
orders that supply the market with its dynamics during downward
moves[28].
3. I have not defined the size of the gap, but I can certainly state that the
bigger it is, the better. This is for two reasons: first, a large gap comes
with the large possibility that it will be closed; secondly, a large gap
allows us to achieve a higher profit, thus the risk/reward ratio is more
beneficial than in the case of small gaps. Here it is worth adding that
in the case of large gaps, during the initial phase of a session, uptrends
are frequently sustained for a moment. In my view, however, this is
a beneficial phenomenon, because I assume that the gap will in any
event be closed, thus a price moving upwards provides additional
potential for profit from our transaction.
 Let us take a look at two examples of gaps meeting the conditions we
just set out a moment ago (Diagram 18.30), and we will also review the
levels applied to specific transaction orders (apart from the protective
order; Diagram 18.31).

Diagram 18.30. Gaps meeting the transaction criteria on a daily chart

Diagram 18.31. Transaction concluded on the basis of a gap

IB TOGETHER WITH GAP

In this strategy, IB is of key importance. First and foremost, it is vital to

determine how we set our stop-loss order. Indeed, without IB we could also
set our protective order based on another method, but this can lead to
certain problems. When we open a short position at the beginning of
a session where a gap is created, we are frequently without natural
resistance levels on our chart above the price at which we entered the
market. A consequence of this is the need to establish a large stop-loss[29],
and as a result a poor risk/reward ratio.
The likelihood of a closure of the gap I have presented is high, at
approx. 70-75%. However, before the price reaches this level, it is possible
that the trend will continue moving in a direction consistent with the open.
This is why, in my approach, I do not enter the market immediately after it
opens, but I switch to a lower time frame and observe how the price
behaves there. Because I want to open the transaction as quickly as
possible, I usually analyze the market at a very low time frame – between
m1 and m5. When an IB is forming at a low time frame, it is at this
moment I place the relevant order on the breakout of the inside bar and set
my stop-loss at the opposite of its extreme. We can see this in Diagram
18.32.

Diagram 18.32. Transaction plan based on daily gap and occurrence of IB at lower time
frame

The day has opened with an uptrend gap. All the conditions I have
written about earlier are fulfilled, so we can start seeking a good moment
to open the transaction. The eighth bar on the 3-minute chart turns out to
be an IB. Thus, I set my sell stop order at a level of $2,059.25, and buy
stop (stop-loss) at $2,061.26, expecting a reaction by the market. The price
breaks out of the IB heading upward, which is why I cancel both orders
and wait for another chance. This chance comes six bars later. Entering the
position happens 1 tick below the inside bar, at a price of $2,058.75. The
stop-loss is set at the other side of the inside bar, at a price of $2,026.00
(our risk is therefore 3.25 points). The position is opened. I am waiting for
the closing of the gap and execution of the take-profit order at a level of
$2,046.25, which gives me 12.50 points of profit. Because I entered the
market on the basis of an IB formation, I succeeded in achieving
a risk/reward ratio of 3.85 to 1 – not bad at all.
The benefits that come from the combination of the type of gap under
discussion with IB are as follows:
– the inside bar is the signal bar, which allows us to reduce the size of
our stop-loss
– besides the fact that the stop-loss is significantly smaller than if we
were to set it solely on the basis of the gap, we also benefit from the
greater potential for profit resulting from the large difference between
yesterday’s closing price and today’s opening price. These two factors
used in concert allow for some transactions to achieve a risk/reward
ratio of 5 to 1

In Diagrams 18.33 and 18.34 I have presented examples of transactions

based on a gap and IB formation.
Diagram 18.33. Transaction opened on the basis of a gap and IB (no. 1)
Diagram 18.34. Transaction opened on the basis of a gap and IB (no. 2)
.

You have reached the end of the second book. I hope that the conclusions
from the analysis of individual filters are themselves a source of inspiration
and ideas you will use in your trading. However, if you want to see ready
transaction strategies based on the inside bar setup, I encourage you to read
the third volume of the Inside bar. Practical Application of the Inside Bar
on the Market, which is available on Amazon.com.

In the third book, I discuss how to set stop loss and take profit orders based
on the inside bar setup and present six complete trading strategies – one
short-term, two medium-term, two long-term and a mechanical one.

Find my book on Amazon.com: Inside bar. Practical Application of the

Inside Bar on the Market.
 Appendices

Table 1. Effect of day of week consolidated results in short-term approach

Table 2. Effect of day of week consolidated results in medium-term approach

Table 3. Effect of day of week consolidated results in long-term approach

Table 4. Functioning of IB on particular markets in short-term approach
Table 5. Functioning of IB on particular markets in medium-term approach
Table 6. Functioning of IB on particular markets in medium-term approach
 Footnotes

[7] WIG20 is a stock index of the 20 biggest companies listed in the Warsaw Stock Exchange
while mWig40 is a stock index of 40 middle sized companies.

[8] I would like to remind you, however, that the closing of a transaction after 1 day, 5 days, or
10 days results from the research method adopted and is not my proposal for a way of setting up
defensive or profit-taking orders.
[9] Here I would also like to point out one more cause of the reduced number of transactions in
trend strategies. In performing my tests I operated under the assumption (which traders
frequently do in practice) that a new transaction can only be opened once the previous one has
been closed.

[10] IB consistent with breakout always achieved good results. The surprise does not, therefore,
come from the mere fact of the advantage over the remaining categories, but the size of that
advantage. The difference between the average trade value for the best and the worst test is $137.
[11] The classification I have adopted is based on my subjective observations. It seems that two
groups are not enough, while five are too many. I think that a test can be based on a division into
four categories (or three, as I have done here).

[12] This filter could be used by a trader gifted with patience and who places a premium on
quality. For a trader seeking maximum profits (and tolerant of greater drawdown), this filter is
not a good solution. After all, a 470% rate of return does not hold a candle to 2,617%.
[13] However, the opposite may also be true. It can always turn out that a given strategy works
better on a calm market than an overheated one.
[14] Aggregate results are presented in an index at the end of the book.
[15] I refer those interested in the subject of particular market formations to T. Bulkowski,
Encyclopedia of chart patterns, New Jersey 2005.
[16] A 1-2-3 formation should not emerge in the course of a consolidation. To learn about
avoiding trades in the course of a developing horizontal trend, I recommend reading Joe Ross’
Day trading.
[17] Joe Ross does not define the range of a breakout from 1-2-3 pattern. It is, however, certainly
much larger than the potential for profit resulting from the IB. In opening a position at the
breakout of bar 3, the trader should establish orders for closing profitable transactions around
stop-loss hunting levels, or trade with the trend and take advantage by using the right tools to
follow the developing price movement.
[18] These formations are only examples of variations of the typical 1-2-3 formation. There are
many combinations, and it is not possible to discuss all of them. Interested readers are referred to
publications by Joe Ross. The diagram above presents examples which allow me to briefly
present various mechanisms by which the formation develops.
[19] Precisely the opposite conditions should be fulfilled by every 1-2-3 low.
[20] Recall that a swing high is a bar which has at its immediate left and right sides bars with
a lower high.

[21] Precision in determining whether a given high or low is at the same level is entirely optical.
For example, on a 1-minute chart I expect an accuracy of 1 tick, whereas with a daily chart I can
accept a divergence of even a dozen ticks.
[22] In these situations, the market generally offers the possibility to close the transaction at
a break-even level, or even with a small profit.

[23] A simple stop-loss hunting can conclude with both a reversal of the tendency and
a successful breakout.
[24] Bar 1 can have a higher high than bar 2, and bar 2 can have a higher high than bar 1. The
same holds for the relation between bars 4 and 5.
[25] Such a gap can be seen on every chart, but it is easiest to spot on a daily one.
[26] For example, instruments traded on the Warsaw Stock Exchange.
[27] This is a counter-trend strategy and generates only sale signals.
[28] Stop-loss orders by traders shortening and set above tops are less common, as long positions
are far more popular on the market. The S&P 500 is an asymmetric market.
[29] The following dependency exists: the larger the stop-loss, the greater the chance that the gap
will close, but also the weaker our risk/reward ratio. A small stop-loss, however, increases the
chances of us being thrown out of the market.