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The Implication of a Consecutive Outside and Inside Months?

What is an outside month pattern?


An outside month pattern is a potential reversal price pattern that often signals a change in the trend of a price chart. It is depicted on the graphs by an engulfing type pattern. The high and low prices for the month often exceed the high and low prices of the prior month trading range. An outside month is rare, but it is a simple pattern and easy to spot on the monthly charts.


A pattern such as this does not often occur, especially for major stock market indexes. It suggests a sudden and often long-lasting trend reversal has developed. An outside month is more meaningful and reliable after well-defined and prolonged uptrends or downtrends. It is unusual to witness a perfect positive outside month pattern where the security in question declines and closes the month at the monthly low. A perfect positive outside month pattern where the security ends the month at the top of its monthly high is also rare.


A positive outside month is typically bullish, and a negative outside month is bearish. There is also a third possibility - the security closes the month near the mid-point of its monthly trading range. For instance, the SPX index ended Sep 2020 at 3,363, placing it near the mid-point of its September intra-month range of 3,209.45 and 3,588.1. The pattern is neither positive nor negative. This hint of an undecisive market environment in which the buyers and sellers are deadlocked. When opposing parties do not exert enough influence to alter the prevailing trend, it implies additional time is needed to break the tie. The outcome of October 2020 will become increasingly crucial to help confirm the following scenarios: (1) The resumption of the Mar 2020 bull rally. (2) Validate a market top. (3) The continuation of a volatile and erratic trading condition.


What is an inside month pattern?


An inside month pattern occurs when the monthly price range trades within the price range of the previous month. Practitioners of Japanese candlestick charting recognize this pattern as that of the Harami pattern. It can alert traders and investors to an impending directional trend change in the security in question.


The inside month typically occurs when there is widespread indecision or confusion in the marketplace. It often implies a market environment where the bulls and the bears are in a deadlocked battle as both parties are not strong enough to send the price beyond the range of the prior week. When an inside month develops toward the end of a prolonged downtrend and it nears significant technical support, it can signal an impending bullish trend change. Conversely, an inside month that develops near the end of a prolonged uptrend it can also signal the bull rally is maturing and warns of either a deeper correction or the start of a bear decline.


With 1-day before the end of the month (October), another inside month pattern occurs if SPX closes tomorrow within the prior month low and high range of 3,209.45 and 3,549.85.


Frequency of Outside Months, Negative Outside Months, Positive Outside Months, and Inside Months


Since the 2009 market bottom, there have been nine (9) positive outside months (bullish reversal patterns), four (4) negative outside months (bearish reversals), nineteen (19) inside month patterns (neutral), and only two (2) outside months patterns. Remember, an outside month is rare. It occurs when the intra-month high and low engulfs the prior month's high and low monthly range and then closes the month at or near the midpoint of the current month range. It conveys neither a bullish or bearish market condition but an undecisive or neutral market environment.


The implication of Consecutive Outside Month Followed by an Inside Month

There have been numerous occurrences of an inside month followed by another inside month pattern. There are fewer occurrences of an inside month followed by either a positive or negative outside month, and vice versa. It is rare to witness an outside month followed by an inside month pattern. The last time this occurred was during Dec 2014 and Jan 2015. If you recall, this period coincided with the Euro Zone Debt Crisis (i.e., Portugal, Italy, Greece, and Spain economic collapse), the commodities and oil market crash (global recession fears), concerns of a hard landing in China (i.e., China devalues Renminbi during their economic slowdown), Russia annexes Crimea (escalating geopolitical crisis), and Ebola virus outbreak in West Africa (pandemic concern). The above conditions led to volatile trading in SPX between 1,810 and 2,135 for nearly 2-years. It was not until the November 2016 positive outside month pattern that SPX finally broke out of its trading range.


Fast forward today, amidst the COVID-19 pandemic, an uncertain US presidential election, potential for another global lock-down, and recession fears, an outside month has been confirmed in September 2020. Another inside month (October 2020) may also develop by the end of tomorrow. Although we recognize history does not always repeat itself, given the striking similarities to the outside and inside month patterns that developed during December 2014/January 2015, is it reasonable to expect the next 1-2 years will be equally volatile as SPX trades within a range between 2,700-2,900 and 3,600-3,800?


Source: Courtesy of StockCharts.com


Source: Courtesy of StockCharts.com

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