As contrarians we are often looking for compelling opportunities to fade overextended moves in anticipation of a significant reversal. While overbought technical studies are helpful in determining that a trend might be poised for a reversal, added confirmation in the form of an outside day is always a welcome development which helps to confirm our counter-trend bias.
An outside day occurs when the market consumes the previous daily range. This means that the current day’s highs are higher than the previous day’s high and the current day’s lows are lower than the previous day’s low. When a market is trending in a given direction and daily studies start to reach overbought levels, we will start to look for signs of an outside day that closes in the opposite direction of the trend. In the above example, we can see that Chf/Jpy has been trending higher for 10 consecutive days before finally reversing on Friday. Daily studies were indeed overbought and the reversal on Friday has taken the form of an outside day that looks to be setting up for a close in the opposite direction of the trend (negative close). This is referred to as a bearish outside day. These typed of formation are not common and usually act as a warning sign for a significant reversal in the trend.
Written by Joel Kruger, Technical Currency Analyst for DailyFX.com
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