What Is an Outside Reversal?
Let me explain what an outside reversal is—it's a price pattern on a chart that points to a possible trend change. You see this two-day pattern when a security's high and low prices for the day go beyond the high and low from the previous day's session. On candlestick charts, you might know it as a bullish engulfing pattern after a downward move or a bearish engulfing after an upward move.
Key Takeaways
- Outside reversal is a two-day price pattern that implies a reversal if it runs counter to the existing trend.
- The first day is typically a small range day and the second is a larger range day.
- This pattern is known as an engulfing pattern in candlestick studies.
Understanding an Outside Reversal Pattern
You encounter an outside reversal as a two-day pattern where a candle or bar falls 'outside' of the previous day's candle or bar on a chart. Technical analysts like me use this to spot points where the price action might signal a bullish or bearish reversal of the current trend.
This pattern is one of the more precise ones in candlestick analysis, but you need a strict definition for it to be a useful forecasting tool. I recommend combining it with other data such as trend lines, support and resistance, or technical studies to build stronger trading signals.
Sometimes, you can corroborate it with volume or support and resistance levels. For instance, if a stock shows a bearish outside reversal near trend-line resistance on high bearish volume, that's more reliable than one in sideways movement on low volume.
Bullish Outside Reversal
A bullish outside reversal, or bullish engulfing, occurs when the second candle moves higher. Picture this: a stock dips slightly on the first day, opens even lower on the second, but then rallies sharply by the end of that day. This shows bears were in control initially, but bulls took over, indicating a trend shift.
In charts, you might see something like Amazon.com shares consolidating before a bullish outside reversal kicks off an uptrend renewal, with prices rising in the following days.
Bearish Outside Reversal
A bearish outside reversal, or bearish engulfing, happens when the second candle moves lower. For example, a stock edges higher on the first day, climbs more on the second morning, but then drops sharply by close. This means bulls were leading at first, but bears seized control, signaling a trend reversal.
Look at Cisco Systems shares rising for three days before a bearish outside reversal, followed by a plunge as the trend turns downward.
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