What Are Outside Days?
Outside days are days where a security’s price is more volatile than the previous day as evidenced by a higher high and a lower low. This makes it a two-day price pattern. The difference between the open and close on the second day is larger than the first day, where the open and close of the second day are outside the range of the first day.
The term is commonly used among market technicians and swing traders who look at short-term price patterns which play out over several days or weeks.
The opposite of an outside day is an inside day.
- An outside day is a daily price action that has a higher high and a lower low than the prior price bar.
- It also has an open and close that both fall outside the prior open and close. The bars can both be up, both down, or one up and the other down.
- When the price bars move in opposite directions it's called an outside reversal.
- Context is important when trading outside days. This includes volume, overall trend direction, the direction of the price bars within the outside day pattern, and the direction of the price bar following the pattern.
Understanding Outside Days
Outside days are a two-bar chart pattern that occurs when the current day’s price bar has a higher high and a lower low than the prior bar and the open and close of the second day fall outside the open and/or close of the first day. Unlike bullish or bearish engulfing patterns, outside days look at an entire price bar, including both the high and low and the open and close.
An outside day shows that volatility is on the rise. The longer body (the difference between open and close) of the second bar shows greater conviction on the part of the buyers or sellers, and provides clues as to the future direction of the security. If the second price bar heads lower, it shows sellers were in control and the price may continue down. If the second price bar was up, it shows buyers were in control and the price may continue to rise.
Outside days often serve as part of a continuation pattern in the direction of the last few price bars. For example, a bullish outside day occurring during an uptrend is a signal that the uptrend is expected to continue. A bullish outside day is when the price heads higher on the second day, and meets the general criteria of an outside day (higher high, higher low, longer body).
However, outside days can also act as reversal patterns depending on the context. An outside reversal is an outside day pattern in the opposite direction of the prior price bar. For example, if the prior price bar was up, an outside reversal would be a down bar with a longer range both in terms of highs and lows and the open and close.
Trading Outside Days
An outside day can manifest in several ways based on whether the first bar is up or down, and whether the second bar is up or down. Here are the combinations:
- First bar up, second bar up.
- First bar down, second bar up.
- First bar up, second bar down.
- First bar down, second bar down.
All these combinations are outside days, but when the bars are moving in different directions those are called outside reversal patterns.
For additional context, traders don't typically look at only the two price bars. They look at the surrounding price action as well.
- The price may be rising into the pattern.
- The price may fall and then form the pattern.
- The pattern may also be in a range and then form the pattern.
If the pattern is in a range when the outside day forms, it may not be a significant development unless the outside day occurs when the price is breaking out of the range. An outside day within a range could just mean a continuation of the choppy trading already seen.
In an uptrend, if both bars point up, or even just the second one, that could mean a continuation of the uptrend. If both of the bars, or even only the second one, are pointed down that could mean the uptrend is stalling and the price may head lower.
In a downtrend, if both bars are pointed down, or even just the second one, that could mean a continuation of the downtrend. If both of the bars, or even only the second one, are pointed up, the price may start heading higher.
Instead of guessing what the price will do, traders will often wait until the following day—the third day—to see where the price goes. If the pattern and context suggest a move higher, then if the price starts moving higher on the third day a trader may consider entering a long position. If the pattern and context suggest a move lower, and the price moves lower on the third day, then the trader may consider exiting long positions or entering a short position.
One other thing to consider is volume. An outside day with larger than average volume shows more interest and conviction than a low volume outside day. Some traders may disregard a low volume outside day and wait for a more compelling trade signal to act on.
Outside days are short-term patterns and don't indicate how far the price will move after the pattern. Sometimes the pattern may kick off a new large trend, while other times the price may falter soon after the pattern completes.
Example of an Outside Day and Outside Reversal in the Stock Market
Outside days are a fairly common pattern. If looking at a one-year daily chart, typically there will be many examples of outside days.
Several outside days have been highlighted on the following Amazon.com Inc. (AMZN) chart.
These were not high-volume outside patterns. As can be seen, the price continued to drift in the direction of the overall trend. The left-most circled pattern was an outside reversal pattern, yet it failed to halt the advance. This is why it is important to wait for confirmation. While the reversal pattern signaled a possible move lower, the price gapped higher the following (third) day, nullifying the signal.
The patterns were also all fairly small, with no wide-ranging days. With the price moving higher, and no strong conviction selling days to warn of a reversal, the latter two patterns could have been used as continuation patterns. The price moved higher following the pattern on those two occasions.