Inside Days: Strategies for This Powerful Short-Term Stock Trading Pattern

June 25, 2010

Mish's Daily Articles

By Mish Schneider

Marketgauge created special stock trading software that scan for inside days, as we recognize just how significant this short-term trading pattern is for finding trades that have reached an inflection point. One of our tools, the Nuggets List, highlights stocks and ETFs that are in the strongest technical setup for buy opportunities. If any of these stocks/ETFs had an inside day on any given trading day, we view that as a great opportunity to either buy or sell on a new entry, or add to an existing position.

What Does Inside Day Mean?

An inside day occurs when the entire daily price range for a given security falls within the price range of the previous day. Inside day often refers to all versions of the Harami candlestick pattern and can be very useful for spotting changes in the direction of a trend.

"An inside day is often used to signal indecision because neither the bulls nor the bears are able to send the price beyond the range of the previous day. If an inside day is found at the end of a prolonged downtrend and is located near a level of support, it can be used to signal a bullish shift in trend. Conversely, an inside day found near the end of a prolonged uptrend may suggest that the rally is getting exhausted and is likely to reverse." -Investopedia

Whether you are a daytrader, miniswing or swing trader, identifying the breakout/down of the inside day and then going with the momentum is a useful and profitable strategy to place in your trading tool belt.

Thoratec Corporation (THOR) Mini Swing Trade Example

THOR Chart

First example is using the inside day breakdown for a miniswing trade. THOR was featured on our Nuggets List as it had made new all time highs even as the overall market had been ticking lower. On June 16, THOR had traded in a wide range, making a high of 47.93 and a low of 44.70. The next day, (circled on chart) THOR had both an inside day and a narrow range day (also typical of an inside day as well as lighter than average volume). The 18th, THOR traded in yet another inside and narrow range. 2 inside days in a row is an even clearer signal of the indecision by traders as to the next direction of the stock. The week ended and for those traders who study charts as part of their weekend routine, surely must have noticed that THOR paused. Monday, June 21, the range narrowed once again to a high of 47.26 in the low of 46.03. Now, after three inside days, it was apparent that something was going to happen in this stock. The following day, THOR opened up at its high of 46.67 and then as the day progressed, broke the recent low of all those inside days (45.60). We shorted THOR as it broke 45.60 and placed our stop above the high of the day or about 3/4 of the Average True Range. THOR proceeded to sell off to set a daily low of 44.18. We covered 1/2 of the position at 44.70 or 1/2 ATR from entry and then placed a no loss stop for the balance. On June 23, THOR continued to trade lower. We moved the stop to cover to just over the 10 day moving average or 45.23, which would give us a small profit on the balance rather than a no loss. We exited the trade at 43.20 or 1 1/2 ATRs from the entry-our target for miniswing trades.

Apple (AAPL) Swing Trade Example

AAPL Chart

In the example of AAPL, establishing a swing trade combining the power of an inside day, along with a phase change and then, a higher open helps you time your entry with a clear risk. On March 18, 2009, following a phase change in AAPL to bullish, 2 inside days in a row occurred. (See highlighted area). On March 23, the ranges of all 3 days prior were broken on a higher open, which gave a great signal for a long entry at 107.00. The risk for that entry was the low of the day or a close below the adaptive moving average, which turned out to be about the average true range or five dollars, as the low that day was 101.75. As a swing or position trade, there was no reason to exit until the phase changed from bullish to warning with confirmation on December 7, 2009. The exit price would've been about 189.00 with a profit of $82.

The inside day is a powerful short-term trading strategy that can be used for day trading, mini swing and/or position trading. One or more inside days in a row, regardless of your timeframe, is an indication that that particular instrument has paused and compressed offering low risk opportunities.