Outside days are significant price action patterns that traders, particularly swing traders and market technicians, use to gauge market volatility and potential future price movement. They are characterized by a security's price reaching both a higher high and a lower low compared to the previous day's price action.
Key Features of Outside Days
An outside day is defined by its attributes:
- Higher High and Lower Low: The current day's price must exceed the previous day’s high and low.
- Opening and Closing Price: The opening and closing prices of the current day should lie outside the range established by the previous day.
- Two-Day Pattern: An outside day is effectively a two-bar pattern, taking into account the price behavior of two consecutive days.
Types of Outside Days
There are several combinations of outside days based on daily price action:
- First bar up, second bar up: Indicates potential continuation of an upward trend.
- First bar down, second bar up: May signify a reversal pattern where buyers are beginning to take control.
- First bar up, second bar down: Often seen as a warning sign that sellers are regaining strength.
- First bar down, second bar down: Indicates continued selling pressure and a possible continuation of a downtrend.
When there is a directional conflict—where the two days move in opposite directions—this is known as an outside reversal.
The Significance of Context
While the characteristics of outside days are essential, understanding the broader market context is equally crucial. Context includes:
- Volume: An outside day accompanied by higher-than-average trading volume suggests stronger conviction behind the price movement.
- Trend Direction: The direction of the trend leading up to the outside day can affect its implications—for example, an outside day during an uptrend is generally seen as a continuation signal.
- Price Action Prior to the Pattern: The behavior of prices leading into an outside day can provide insight into its significance. An outside day occurring at the end of a consolidation range might indicate a breakout.
Trading Outside Days
Traders often wait for additional confirmation before taking action based on an outside day. This confirmation usually comes on the third day after the outside pattern forms. They may look for:
- A follow-through in the expected direction after the outside day.
- Adjustments to their trading strategy based on the price movement observed on the third day.
For example, if an outside day is noted, and the price moves higher on the following day, a trader might consider opening a long position. Conversely, if the price drops, they might close existing long positions or short the security.
Volume Considerations
Volume plays a pivotal role in validating the outside day pattern. A high-volume outside day suggests that the market has participated actively in the move, indicating stronger conviction from traders. Conversely, a low-volume outside day might lead some traders to disregard it, waiting for a more compelling signal.
Patterns and Market Behavior
Outside days can either trigger new trends or signify pauses in prevailing trends, making them valuable signals for traders. However, they are short-term patterns and do not guarantee extended price movement.
Example
To illustrate the concept of outside days, consider a hypothetical scenario of Amazon.com Inc. (AMZN) stock:
- Suppose on Day 1, AMZN's price closed at $3,000, and on Day 2, it opened at $2,950, rallied to $3,100, but closed at $2,950. Here, Day 2 is an outside day as it has a higher high of $3,100 and a lower low of $2,950 compared to Day 1.
Even in this example, the lack of significant volume on the outside day and the absence of strong selling might suggest that the overall trend will continue, rather than reverse.
Conclusion
Outside days are versatile indicators widely utilized in technical analysis. Traders leverage the context and features of outside days to optimize their trading strategies, ensuring they remain adaptable to changing market dynamics. By combining outside day indicators with volume analysis, trend direction, and price action context, traders can enhance their decision-making and improve their trading outcomes. Whether viewed as a continuation signal or a reversal indicator, the significance of outside days cannot be overstated for those navigating the complex world of equity markets.