Lesson #17 Understanding the Reversal Patterns

Check for a Prior Trend

A reversal pattern can only be considered as a pattern if there is a prior reversal trends. To see a bullish reversal, the requirement would be a preceding downward trend. For bearish reversal, the requirement would be a preceding upward trend.

You will be able to spot these trends using several technical analysis tools. You can use trend lines and moving averages for this purpose.

Identifying a Hammer and Hanging Man Pattern

If you see a hammer and hanging, you might notice that the two would be similar. They have different meanings though due to previous price movements and actions. The hammer and the hangman have little bodies. They have black or white color. They have short upper shadows and very long lower shadows.

Bullish reversal pattern is indicated by the hammer emerging during a downward trend in the market. A hammer indicates that the market is hammering the bottom.

If market prices are sliding and the hammer comes, it signifies that the bottom pit is approaching and prices will eventually come up. The longer lower shadow is an indication that the sellers are driving the prices lower. This is offset or resisted by the buyers as they fight pressures and closed the prices near the open.

Take note however that if you see a hammer forming at the downward swing, this does not mean you automatically place buy orders. You need to confirm the pattern first before entering a position, just to be safe.

A white candlestick closing above the open of the candlestick on the left of the hammer is a good indicator of continuing reversal.

Criteria for Recognition:

• Long shadow should be 2 or 3 times of the real body.

• Small or without upper shadow.

• Trading range position should be at the upper end of real body.

• Real body color is unimportant and has no bearing.

The bearish reversal pattern is shown by the hanging man punctuated by strong resistance level. When the price starts to rise, this indicates that sellers are overwhelming the buyers. Lower prices pushed by sellers are indicated by the long lower shadow.

Buyers resisted by propping up the prices but only at the open. This is an indication that there are no more buyers to keep the price rising.

Criteria for Recognition:

• Long lower shadow should be two or three times the size of real body.

• Without or little upper shadow.

• Upper end trading range for the real body.

• Body color is unimportant. Take note however that black is more bearish than white.

Identifying an Inverted Hammer and Shooting Star Pattern

Inverted hammer and shooting star will also look very similar. The main difference is whether you are positioned in an uptrend or downtrend. These candlesticks have small bodies. They could be black or white. They have long upper shadows with little or no lower shadows.

When prices are falling and the inverted hammer appears, it indicates a possible trend reversal. The long shadow is an indication that buyers are trying to bid higher.

Sellers however are resisting by pushing the prices down. The buyers however overcome and set the closing prices near the open.

Because the sellers failed to lower the price any further, it signals that there are no more sellers. Without sellers, only the buyers will be left at the market.

Bearish reversal pattern is signaled by the shooting star. The price opened at the low but eventually rallied. However, it was pulled back again at the bottom.

This is an indication that buyers are attempting to push the prices upwards. The sellers however clobbered them and frustrated their attempt. There is now a bearish trend at the market because there are no more buyers left. They have been mugged at the floors by the sellers.