Outside Month
Research for Online Investors

by John Dalt

10/31/11

You may have heard the term “outside day.”  Today we conclude an “outside month.”  What is the importance of this chart pattern?  An outside day occurs when a trading day’s high is higher than the previous day and the day’s low is lower than the previous day.  Many times in our SwingTrader, we will sell a stock if the price trades lower than the previous day’s low.  We feel this signals a change in the momentum of the trend we are hoping to capitalize on.  Here is a chart of the S&P 500, I have drawn horizontal lines at October’s high and low.

The bars on this chart are weekly readings.  You can see the September and even August weekly bars are “inside” the extreme readings from October.

Many traders will interpret an outside day as a strong signal the market is ready to move in the direction of the short term trend or the direction at the close.  Historical analysis does not bear this out, but chartists look for any hook to predict future price moves.

Research by Bulkowski at the Encyclopedia of Chart Formations shows that outside days have a 42% failure rate in predictive value.  He also finds that these formations are the most powerful when they occur on low volume.

How often do outside months occur?  Last May was an outside month, which started the market lower for the next five months.  January was also an outside month, which was followed by lower index prices in February before the market turned higher to start its spring rally.  July of 2009 was an outside month, in the middle of the Bull Run after the March 2009 low.  January of 2009 was an outside month as the market worked lower.  Prior to 2009, we have to go back to February 2008 for an outside month.

What can we learn from outside months?  From a timing perspective, an outside month appears to occur when the market is under pressure from outside events.  Outside months also occur when the market is changing directions.  The index sets a low or high then reverses strongly to close out above or below the previous month.

It is important that the index close at or near the extreme outside position if we are to interpret the chart as a reversal of the previous trend.  We can view October as a trend reversal of the previous down market.

Now we just have the headline risk to worry about.

All sins are not crimes, but all crimes are sins.---Pastor Gene Eason

The information presented in this newsletter is based on generally available news releases, corporate filings, current events, interviews and the editor’s opinions.  It may contain errors and you should not make investment decisions based solely on what you believe you have read here.  Do your own research, it is your money.  If you lose it, it is your responsibility, not ours or your grandmothers!  The editor may or may not have a position in any securities discussed.  The editor may have held a position in a security earlier, or in the future.

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