What is an Inside Day?
An inside day is a two-day price pattern that occurs when a second day has a range that is completely inside the first day's price range. The high of the second day is lower than the first, and the low of the second is higher than the first.
Inside days show a contraction in volatility and are often a continuation pattern. This means that following the inside day the price will often continue moving in the same direction after the pattern as it did before. That said, the pattern is common and frequently insignificant.
- An inside day is a common pattern where the high and low of one day occur inside the high and low of the prior day.
- The pattern is more often than not a continuation pattern.
- If trading a breakout from the pattern, the highest probability trades are ones where the overall market direction aligns with the direction into and out of the two-day pattern.
Understanding the Inside Day
Inside days are common. On a daily chart, they may occur several times per month in many assets. This means that many inside days will provide little information to a trader and will not result in a significant price move following the pattern.
An inside day shows that volatility has dropped from the prior day. The market is taking a pause. This is why the pattern is often considered a continuation pattern. In the Encyclopedia of Chart Patterns, Thomas Bulkowski found that in over 29,000 samples of the pattern, the price continued in the same direction it entered the pattern 62% of the time.
If attempting to the trade the pattern, the best results tend to come with trading it as a continuation pattern. For example, if looking to the buy, it should be a bull market (if trading stocks), the stock should be trending higher when it forms the inside day, and then the price should exit the pattern to the upside.
In the example above, the trader could buy when the price moves above the top of the pattern, which is the high of the first candle of the two-bar pattern.
To enter short, the trader would short-sell when the price dropped below the low of the pattern. The short should align with a bear market (if trading stocks), the price should be moving lower into the inside day, and then the price should break below the two-bar pattern.
A stop loss is placed outside the pattern on the opposite side of the entry. If going long, the stop loss is placed just below the low of the two-day pattern, for example.
The inside day pattern does not have a profit target attached to it. Traders can utilize other methods to collect profits, such as a trailing stop loss, risk/reward ratio, an indicator or moving average, or looking for other candlestick patterns to signal an exit.
Example of an Inside Day
The following chart shows multiple inside days in Bank of America Corporation (BAC) stock. This shows how common the pattern can be. Not all inside days result in a significant price move following the pattern.
The first two patterns occur during a price rise. The price then breaks above the pattern and the price continues to the upside. Ideally, this is the structure desired for a long trade.
For the inside days that follow, some are preceded by a price advance or decline, while others occur when the price is moving predominately sideways. Traders could have avoided some of the poor signals by only taking a trade if the breakout occurs in the same direction as the price direction that preceded the two-day pattern.