Outside Day Trading Strategy (Backtest)

Last Updated on November 21, 2022 by Oddmund Groette

While trading price bar patterns may not be a robust trading approach, within the right chart context, it is possible to create robust signals. This is true for the outside day price pattern, which is quite popular among price action traders. Wondering what is the outside day trading strategy?

An outside bar strategy is a method of trading that uses the outside bar price pattern to find trade setups. Although very popular among price action traders, the strategy can be subjective because outside bars are challenging to interpret since they heavily rely on the context in which they take place. Whatever strategy you create with the pattern has to be backtested to be sure it works.

In this post, we take a look at outside day trading strategy and we’ll also make a backtest.

What is an outside day (bar) in trading?

Also known as the outside bar, an outside day is a two-bar price action pattern that forms when the current day’s price bar has a higher high and a lower low than the previous bar, and the open and close of the second day fall outside of the first day’s open and/or close. It is similar to the engulfing patterns, but in contrast to engulfing pattern, an outer day consumes the full price bar of the previous day, including the open, high, low, and close.

An outside day reveals that volatility is on the rise. The second bar completely consuming the full range of the previous day’s range indicates stronger conviction on the side of the buyers or sellers and offers hints about how the price might move going forward. If the second price bar declines, it indicates that sellers were in charge and that the price may drop further. Likewise, if the second price bar was up, indicating that purchasers were in charge, the price might go up.

There are different configurations of the outside bar pattern, depending on whether the first bar is up or down and whether the second bar is up or down. These are the four configurations:

  1. The first and second bars are up
  2. The second bar is up; the first bar is down
  3. The second bar is down; the first bar is up
  4. The first and second bars are down

Even though all of these combinations are outside days, only those patterns where the first and second bars are in opposite directions are referred to as outside reversal patterns.

What is an outside bar strategy?

An outside bar strategy is a method of trading that uses the outside bar price pattern to find trade setups. Although very popular among price action traders, the strategy can be subjective because outside bars are challenging to interpret since they heavily rely on the context in which they take place. Whatever strategy you create with the pattern has to be backtested to be sure it works.

The main thing about trading the outside bar strategy understanding what is going on in the price action. The pattern can be traded in different ways, depending on the configuration of the component bars and the direction of the price swing where it occurs.

If the component bars are in the same direction (or even in opposite directions) but the outside day bar is in line with the prevailing trend, the outside day pattern can function as a continuation pattern. During an upswing, for instance, a bullish outside day bar indicates that the trend is likely to continue. Likewise, in a downswing, a bearish outside day bar is a hint that the trend is likely to continue.

However, outside days can also function as reversal patterns depending on the situation. An outside day pattern that is in the opposite direction of the previous price bar is known as an outside reversal. For instance, an outside reversal would be a down bar with a longer range if the previous price bar had been bullish and the pattern occurs in an upswing. This becomes a bearish outside-day reversal, and if it is around a resistance level, it could be a signal to go short.

Is an outside day bullish or bearish?

A bullish outside day pattern is like a stronger version of the bullish engulfing pattern. It occurs when the second price bar is bullish, regardless of the direction of the first bar. Here is how it can form on a stock chart: on the first day, the price makes a small downward move, but on the second day, it opens lower than the first day and then rallies sharply higher than that first day. It implies that the bears had control of the market, but bulls took over and overwhelmed them, which indicates a shift in the prevailing trend.

The bearish outside day pattern is a stronger version of the bearish engulfing. It forms occurs when the second price bar is bearish, regardless of the direction of the first bar. For example, a stock may make a small move higher on the first day, then climb even higher on the second day before falling sharply below the low of the first day by the end of the second day. This demonstrates that the bulls had control of the market before the bears took meaningful control, indicating a shift in the overall trend.

What is an outside day reversal?

An outside reversal day pattern is a type of outside bar that suggests a probable shift in trend on a price chart. Its formation depends on the configuration of the two price bars that make up the pattern and the price swing it occurs. An outside day reversal is formed when the day’s high and low prices surpass those of the previous day’s trading session but close in the opposite direction of the previous day’s bar and the price swing within which it forms. In an upswing, it becomes a bearish reversal day if it closes lower, and in a downswing, it becomes a bullish reversal day if it closes higher.

Although the outside reversal day pattern is one of the more accurate candlestick patterns, you don’t trade it alone. For the pattern to be an effective forecasting tool, it must be combined with additional technical analysis data, such as trend, support and resistance levels, pivot levels, and Fibonacci levels. That is how technical analysts and seasoned traders use it to create trading signals.

Outside day trading strategy backtest

An outside day trading strategy backtest with trading rules, settings, and historical performance is coming shortly.

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