James Brumley, of BigTrends.com, details the specifics of inside days, which can be particularly strong trend reversal signals—both bullish and bearish—because of their relative shape and what that shape suggests about the changing mood of the market.
Candlestick Charts: Inside Days
Inside days are a two-bar pattern that often mark a major reversal of a trend because of their relative shape and what that shape suggests about the changing mood of the market.
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Specifically, the inside day pattern consists of an open-to-close range for the first bar that is above and below the open-to-close range of the second bar. Also, the direction of the open-to-close movement are different for each day. [Note that the term 'inside days' assumes a daily chart is being used, but the pattern works on intra-day charts as well as weekly/monthly charts.]
Bearish inside days close lower than the open on the second day, following the first day's bar that consists of a close above the open and typically occur after a prolonged rally. Conversely, bullish inside days are marked by a close below the open for the first bar, then a close above the open for the second bar of the pattern. Bullish inside days are more meaningful following a prolonged downtrend.
The ideal inside day will also be marked by a low for the second day that's higher than the first day's low, while the high for the second day's bar would ideally be below the first day's high. Perfect inside days are a rarity, however. Sometimes the spirit of the pattern is enough to signal a reversal.
Examples will help illustrate the idea.
On the chart of United Technology (UTX) below, we can see an inside marked the end of a rally and the beginning of a pullback.
UTX Daily Chart:
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Genworth Financial (GNW) reversed a downtrend with an inside day, as illustrated below.
GNW Daily Chart:
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Note that some inside day bars lie completely (from low to high) inside the prior day's open-to-close range. These inside days can be particularly strong reversal signals, both bullish and bearish. Still, some sort of confirmation—like follow-through from the bar immediately after the second bar of the inside day pattern—is suggested whenever waiting is possible.
By James Brumley of BigTrends.com
