Inside Days: Definition, Trading Strategy, Examples, Vs. Outside

What Are Inside Days?

Inside days are represented by a candlestick pattern that forms when a security has a daily price range within the previous day's high-low range. Candlestick patterns are price charts used in technical analysis to display a security's high, low, opening, and closing prices for a specific period. Traders use these patterns to predict price moves based on historical trends. So when a security trades "inside" the upper and lower bounds of the previous trading session, this could mean the price is consolidating, that is, moving within stable bounds without a clear trend to go on.

Inside days can be contrasted with outside days when the day's candlestick chart goes past the bounds of a prior day's high and low. An outside pattern suggests increased market volatility. If an outside day emerges after a prolonged trend, this can be a strong signal that the trend is losing momentum, and a reversal could be imminent, though this depends on the context.

Understanding Inside Days

A candlestick chart is a popular way of visually depicting the intraday trading activity of an asset over time. A vertical line marks the day's high and low points (known as the "wick" of the candle), while the thicker "body" of the candle indicates the security's open and closing price for the trading day. An inside day occurs when the candlestick of one trading day's high and low fall within the boundaries of the prior day's or days' highs and lows. Examples of inside days are marked on the example chart below.

Inside days can indicate uncertainty in the market about a security, showing little price movement relative to the earlier trading days. However, when several inside days happen in a row, it is more likely that the stock will soon break out of its trading range since a continually dwindling price range is unsustainable. The direction of the breakout, though, cannot be determined just by looking at this chart pattern. Instead, it must be matched with other technical analysis tools to predict whether the breakout will be upward or downward.

Interpreting trading charts like candlesticks is a highly specialized practice and must be done carefully. Inside days interest traders because they believe that's when the security is getting ready for a move up or down. After reviewing other technical analysis tools, traders might then have enough confidence to make a play on the movement of the security price.

Examples of Inside Days

Let's consider a hypothetical example to illustrate an inside day. Suppose these are the results from a stock trading over two consecutive days:

• Day 1: The stock opens at $50, reaches a high of $55, falls to a low of $48, and then closes at $52.
• Day 2 (the inside day): The stock opens at $51, climbs to a high of $54, drops to a low of $49, and closes at $53.

In this example, Day 2 is an inside day because its entire price range (high of $54 and low of $49) is within the price range of Day 1 (high of $55 and low of $48). This pattern suggests a consolidation in the stock’s price, indicating some indecision among investors.

For those who know other aspects of technical analysis, other patterns can help interpret this candlestick pattern. For example, an ascending triangle chart pattern, coupled with inside days, may precede a bullish movement in the stock. Conversely, a descending triangle is historically a bearish signal. Other common pairings with inside days as a short-term trading strategy are the relative strength index (RSI), moving average convergence divergence (MACD), and simple moving averages (SMA).

Additional patterns looked to are known as the three inside up and three inside down charts. These are three-candle reversal patterns, with the bullish version having a long downward candle, a smaller upward candle contained within the prior candle, and then another upward candle that closes above the close of the second candle. The bearish reversal has a long upward candle, a smaller downward candle contained within the prior candle, and then another downward candle that closes below the close of the second candle.

How to Trade the Inside Day Pattern

Trading the inside day chart pattern involves recognizing a specific pattern in price charts and using it to make more informed trading decisions. It also requires a strategy that capitalizes on potential price moves, whether bullish or bearish, following the pattern.

Inside Days in Bullish Markets

When identifying an inside-day pattern, you must determine whether the overall market or specific security is bullish. This can be corroborated by analyzing longer-term charts to confirm the prevailing trend as upward. Also, the trading strategy involves waiting for a price breakout from this pattern. In a bullish market, traders look for prices to break above the inside day's high.

Generally, an entry point would be set when the price breaks above the high of the inside day pattern. Some traders wait for the closing price to be above the high to confirm the breakout. As a risk management technique, traders would also place a stop-loss order just below the low of the inside day or at a predetermined percentage or price point to limit potential losses if the market moves against the position. Moreover, a profit target could be set based on previous resistance levels, a specific risk-reward ratio, or other technical indicators.

Traders would also integrate technical analysis tools like moving averages, the RSI, or MACD to confirm and refine their entry and exit points. Indeed, while technical analysis patterns like inside day patterns can be a powerful tool, there are risks. Traders should also conduct thorough research and combine technical analysis with other techniques, such as fundamental and quantitative analyses, for a more comprehensive approach.

Inside Days in Bearish Markets

Similar to bullish markets, initially, the pattern needs to be identified. Also, before considering the trade, traders should confirm that the market or security is in a bearish trend. This can be done by examining longer-term charts, such as weekly or monthly charts, to ascertain that the overall direction is downward.

Indeed, traders perceive it critical that when in a bearish market, there should be a pause in execution until the price breaks down from the inside day pattern. Specifically, traders would look for the price to break below the low of the inside day. This breakdown could signal that the bearish trend will continue.

Generally, traders would enter a short position when the price breaks below the low of the inside day pattern. Some traders may also prefer to wait for the daily close to be below the low to confirm the breakdown. To manage risk, traders would place a stop-loss order just above the inside day's high or at a predetermined percentage or price point. This limits potential losses if the market unexpectedly moves higher instead of lower.

Traders would determine a profit target based on previous support levels, a specific risk-reward ratio, or other technical indicators. Similarly, in bull markets, while patterns like the inside day can provide valuable trading signals, these patterns are not foolproof and should be part of a comprehensive trading strategy.

The Bottom Line

The inside-day chart pattern is a technical analysis tool, characterized by a security's or index's price range remaining within the range of the previous day, signaling potential market indecision and a coming breakout. Effective trading strategies typically combine trend analysis and other technical indicators to validate the breakout direction. Traders typically employ this pattern with the prevailing market trend, setting clear entry points, stop-loss orders, and profit targets. However, its effectiveness can be limited by false breakouts and market sensitivity, underscoring the importance of integrating it into a well-rounded trading approach that includes comprehensive market analysis and robust risk management practices.

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