DEFINITION of 'Outside Reversal'
An outside reversal is a price chart pattern in which a security’s high and low prices for the day exceed those of the previous trading session. The outside reversal pattern is also known as a bullish engulfing or bearish engulfing pattern when using candlestick charts.
BREAKING DOWN 'Outside Reversal'
The outside reversal is a two-day chart pattern that occurs when a candle or bar on a candlestick or bar chart falls “outside” of the previous candle or bar. It’s often used by technical analysts to identify bullish or bearish reversals. These kinds of reversal patterns are among the most accurate candlestick patterns, but they do not occur as frequently as other patterns and should be used alongside other technical indicators or chart patterns.
Often times, traders look at volume or support and resistance levels as a way to validate the outside reversal. A stock that experiences a bearish outside reversal when approaching trend line resistance on high bearish volume is a lot more reliable than a stock that is moving sideways and experiences a bearish outside reversal on lower than average volume.
Bullish Outside Reversal
A bullish outside reversal, also known as a bullish engulfing, occurs when the second candle is a move higher. For example, a stock may experience a small move lower on the first day, open even lower than the previous day, but then rally sharply higher by the end of the second day. The idea is that bears had control over the market, but the bulls took over and overwhelmed the bears, which signals a change in the prevailing trend.
In the chart above, Amazon.com Inc. (AMZN) shares were in the midst of a consolidation before a bullish outside reversal signaled a revival of the uptrend. Shares then moved higher over the ensuing days as the trend reversal materialized.
Bearish Outside Reversal
A bearish outside reversal, also known as a bearish engulfing, occurs when the second candle is a move lower. For example, a stock may experience a small move higher on the first day, move even higher the second day, but then fall sharply lower by the end of the second day. The idea is that bulls had control over the market, but the bears took the reins in a meaningful way, which signals a change in the overall trend.
In the chart above, Cisco Systems Inc. (CSCO) shares had a three-day rally higher before a bearish outside reversal. Shares then moved sharply lower the day following the outside reversal in a reversal of the overall trend.
The Bottom Line
Outside reversals are two-day chart patterns whereby the second day’s prices fall “outside” of the previous day’s price range. These reversals can be considered bullish or bearish depending on the direction of the second candle or bar. Traders should keep these chart patterns in mind since they are among the most reliable candlestick chart patterns, although they don’t occur as frequently as other chart patterns in practice.
Traders should be sure to use outside reversals in conjunction with other technical indicators and chart patterns to increase their odds of success.