Outside Days Less Than Fully Conclusive

Outside days are less than a conclusive formation, according to the Encyclopedia of Chart Formations by Thomas N. Bulkowski. The expected response to an outside day with a downside breakout (like Tuesday's) -- more selling -- has a 42% failure rate.

That's rather inconclusive.

Bulkowski did a study of 510 outside-day formations in 51 stocks over five years. He found the pattern, at least for individual names, was fairly common. The stocks failed to move in the predicted pattern four out of 10 instances. A pattern is considered a poor predictor if it fails two out of 10 times. So the outside day with a downside breakout turns out to be little better than a 50/50 predictor -- a toss of a coin.

Some surprising tidbits: The best-performing (negative) outside days turn out to be those with lower volume. Tuesday's volume (even backing out Sirius Radio (SIRI - commentary - Cramer's Take)) was high.

Also, the smaller the formation, the more powerful. Tight outside days with an upside breakout are like coiled springs. The data were inconclusive regarding downside breakouts.

The Nasdaq's recent action (before the outside day) does show heavy churn, suggesting a tiring market. That leads me to conclude that some consolidation and backfilling are required before the next significant leg up.

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Barry Ritholtz is chief market strategist for Maxim Group, where his research and market analysis are used by the firm's portfolio managers and clients in the U.S., Europe and Japan. He also publishes The Big Picture, his macro perspectives on the economy and geopolitics, entertainment and technology industries. At the time of publication, Ritholtz had no position in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Ritholtz appreciates your feedback and invites you to send it to [e-mail].