Key Takeaways
- Outside reversal is a price pattern indicating a potential trend change, identified over two days on price charts.
- The pattern occurs when a security’s high and low surpass the previous day’s range, suggesting possible bullish or bearish market shifts.
- Bullish outside reversals happen when the market moves lower, then rallies higher, signaling a trend reversal driven by buyers.
- Bearish outside reversals appear when the price rises, then falls sharply, indicating sellers have taken control from buyers.
- Technical analysts often use outside reversals with other signals, like volume or support levels, for increased reliability.
What Is an Outside Reversal?
An outside reversal is a two-day chart pattern that can signal a potential trend change, where the current session’s high and low both move beyond the prior session’s range.
After a downtrend, it can form a bullish outside reversal (often shown as a bullish engulfing candle), and after an uptrend, it can form a bearish outside reversal. Traders often look for broader trend context and volume confirmation before acting.
In-Depth Analysis of the Outside Reversal Pattern
Outside reversal is a two-day price pattern that shows when a candle or bar on a candlestick or bar chart falls “outside” of the previous day’s candle or bar. This chart pattern is commonly employed by technical analysts who seek to identify points in the price action which imply a bullish or bearish reversal of an existing trend.
An outside reversal pattern is typically one of the more precise candlestick patterns; however, these patterns require a strict definition to be useful forecasting tools. Technical analysts and experienced traders prefer to build trading signals using this identification in conjunction with other information such as trend, support and resistance or technical studies.
On occasion, traders see volume or support and resistance levels as a way to corroborate the outside reversal. For example, a stock price that undergoes a bearish outside reversal when it approaches trend-line resistance on high bearish volume is considerably more reliable than a stock that is moving sideways and has a bearish outside reversal on lower-than-average volume.
Identifying the Bullish Outside Reversal Pattern
A bullish outside reversal, also called a bullish engulfing, happens when the second candle is a move higher. For instance, a stock may make a small move lower on the first day, then open even lower than the prior day, but rally sharply higher by the end of the second day. The indication is that bears had control over the market, but then bulls took over and overwhelmed them, signifying a change in the prevailing trend.
In the chart above, Amazon.com Inc. (AMZN) shares appeared to be consolidating before a bullish outside reversal marked a renewal of the uptrend. Its stock price continued to rise the subsequent days as the trend reversal took hold.
Recognizing the Bearish Outside Reversal Pattern
A bearish outside reversal, also called a bearish engulfing, transpires when the second candle is a move lower. For instance, a stock may have a small move higher on the first day, climb even higher the second day, but then sharply decline by the second day’s end. This demonstrates that the bulls had control over the market before the bears took the reins in a meaningful way, signaling a shift in the overall trend.
The stock price of Cisco Systems Inc. (CSCO) rose for three consecutive days before a bearish outside reversal. Share prices plunged the day after the outside reversal as the overall trend did an about-face.
The Bottom Line
An outside reversal is a two-day pattern where the latest session’s high and low exceed the prior day’s range, used to flag possible trend reversals.
Bullish versions suggest buyers gaining control after a decline, while bearish versions suggest sellers take control after a rise, and traders often confirm with volume and support/resistance rather than relying on the pattern alone.