What Is an Inside Day?
Let me explain what an inside day is in trading terms. It's a two-day price pattern where the second day has a range that's completely inside the first day's price range. That means the high of the second day is lower than the first, and the low of the second is higher than the first.
You should know that inside days indicate a contraction in volatility and often act as a continuation pattern. This means that after the inside day, the price will frequently continue moving in the same direction it was going before the pattern. However, the pattern is common and often insignificant. Inside days can be contrasted with outside days.
Key Takeaways
Here's what you need to remember about inside days. It's a common technical chart pattern where the high and low of one day occur inside the high and low of the prior day. These patterns are thought to signal a continuation. If you're trading a breakout from the pattern, the highest probability trades are those where the overall market direction aligns with the direction into and out of the two-day pattern.
Understanding Inside Days
Inside days are common occurrences. On a daily chart, they might show up several times per month in many assets. This frequency means that many inside days provide little useful information to you as a trader and won't lead to a significant price move after the pattern.
What an inside day shows you is that volatility has dropped from the prior day. The market is essentially pausing. That's why it's often considered a continuation pattern. According to Thomas Bulkowski's Encyclopedia of Chart Patterns, in over 29,000 samples, the price continued in the same direction it entered the pattern 62% of the time.
When you attempt to trade this pattern, the best results come from treating it as a continuation pattern. For instance, if you're looking to buy a stock, it should be in a bull market, the stock should be trending higher when it forms the inside day, and then the price should exit the pattern to the upside.
In that scenario, you could buy when the price moves above the top of the pattern, which is the high of the first candle in the two-bar pattern. To enter short, you would short-sell when the price drops below the low of the pattern. The short should align with a bear market, the price moving lower into the inside day, and then breaking below the two-bar pattern.
Place a stop loss outside the pattern on the opposite side of your entry. If going long, put the stop loss just below the low of the two-day pattern, for example.
Important Considerations
Keep in mind that the inside day pattern doesn't come with a built-in profit target. You can use other methods to take profits, such as a trailing stop loss, a risk/reward ratio, an indicator or moving average, or by watching for other candlestick patterns to signal an exit.
Example of an Inside Day
Take a look at this chart of Bank of America Corporation stock, which shows multiple inside days. It illustrates how common the pattern can be. Not every inside day results in a significant price move afterward.
The first two patterns occur during a price rise. The price then breaks above the pattern and continues upward. This is the ideal structure for a long trade.
For the inside days that follow, some are preceded by a price advance or decline, while others happen when the price is mostly moving sideways. You could avoid some poor signals by only taking trades where the breakout occurs in the same direction as the price movement that preceded the two-day pattern.
