Candlestick Reversal (or Retracement) Patterns

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Introduction

As mentioned in “Candlesticks The Basics” certain candlesticks have reversal implications dependent on where they sit in a chart - only further confirmation candlesticks (i.e engulfing candles) determine the reversal propositions. In the following section we’ll talk about the most common candlestick patterns and how they go on to form reversal patterns.  All have similar reversal properties, but The Doji reversal should be considered the more robust – or at least a near doji (open and close very near). You'll find a common thread in them all - Market Indecision.

When traders use price action to form their trading strategies the reversal must have further confirmation. Candlesticks are regarded as neutral, bullish or bearish, so need this further confirmation to signify a reversal – otherwise they just form support and resistance levels (which is useful in itself), or confirm a “continuation pattern” in the trend. The actual reversal indicates that buyers/sellers overcame prior selling/buying pressure and we'll discuss this confirmation below. You'll also learn in the following paragraphs that some candlestick patterns consist of 1, 2 or 3 candlesticks, so let's discuss this further...

The Star Position Pattern (3 Candles)

The Star Position Pattern is a reversal pattern, made by two candles and a reversal confirmation candle -  a long body, a short body that gaps beyond the first candle (up or down depending on the prevailing trend). It then needs a reversal confirmation.  We can see this at work in the below chart where the star in a down trend is called the morning star and in an up trend it's called an evening star.

Morning and Evening Star
The Star Position Reversal Pattern

The star candle gaps up or down from the preceding candlestick.  The preceding candlestick will usually have a long candle body, while the star candle will have a small body indicating indecision on where the market is going. The star can be filled or hollow in a bearish or bullish trend reversal. Doji, hammers, shooting stars, spinning tops all have small bodies and can be seen in the star position (See Candlesticks - The Basics for definitions). After the star candle there must be a reversal candle to complete the confirmation.  This star position isn’t easy to find, so pay special attention to it when it happens. Volume plays it's part in the reversal. Ideally there should be reducing volume going into the star and increased volume on it's reversal confirmation candlestick. Pay particular emphasis on the volume of the confirmation candlestick.

The Morning & Evening Doji Star Reversal Pattern

As stated in “Candlesticks - The Basics”, Doji on their own only indicate buyers and sellers are balanced or that price action is limited with indecision. The Morning and Evening Doji Star Reversal is just another version of the Star Reversal Pattern above, but maybe more meaningful. The real relevance of doji depends on the preceding trend or candlestick and it's reversal confirmation. A doji in a ranging market doesn’t tell us anything other than indecision. However, after a trend or after a long candlestick the doji signals that the trend is starting to weaken and price momentum may reverse

Morning and Evening Doji Reversal
The shape of the doji may differ during the reversal, i.e. in our above example the cross and inverted cross may be switched for any Doji as highlighted in Candlesticks - The Basics - (common, long-legged, dragonfly, gravestone, cross and inverted cross are all interchangeable) . When looking for the reversal patterns chartists look for a Doji (or a short body candle at the very least) after a trend then require there to be a reverse confirmation candle (or gap up or down depending on the previous trend). The 3rd candle needs to extend at least half way through the 1st candle for the reversal to be robust. Both the Morning Doji Star and Evening Doji Star are charted above.  Basically, trend activity is interrupted by indecision, leading to a reversal. The forces of supply and demand are starting to equal out at the quoted price and a reversal may be about to occur. Once again, further technical analysis and increased volume on the confirmation candle (3rd candle) is needed to verify any reversal. It's also better to see reduced volume on the the 1st candlestick. 

The Harami Position Pattern

The pregnant woman (Japanese translation "Harami") is also a reversal pattern and is more common than the star position. Basically it is two candlesticks, plus a third candlestick confirming the reversal - the 1st being a long bodied candlestick, the 2nd body nestling within the body of the 1st and the 3rd confirming the reversal. This is graphically represented in the below chart.

The Harami Position Reversal Pattern

The shadows of the 2nd candle don’t have to be confined within the 1st candles body, but it helps. This is a bullish or bearish reversal depending on the previous trend and can be formed by either a hollow or filled body in any combination (The 2nd candle in a harami can also be a doji candlestick). The close of the Harami in a bullish pattern (indicated above) must be higher than the close of the longer filled candlestick. A bullish Harami will be found at the bottom of a downtrend. Bearish is the exact opposite and found at the top of an up trend. 

Saying that the Harami can come in any combination of hollow or filled is true, but a Harami with a hollow 1st candle is considered more bullish and a Harami with a 1st filled candle is considered more bearish. This shows a sudden resurgence in buying/selling pressure prior to a consolidation, then the reversal. A Harami with a 1st filled candle can still be bullish if it’s found at the bottom of a down trend.  they also occur more often than the more bullish hollow 1st candle Harami. 

In our above example, The 1st filled candle indicates that there are still plenty of sellers in the market, but then a small candle that kicks up a little from the previous close indicates that buyers are waiting in the wings for a potential reversal (They may also believe this is an area of support - we'll explore this in a few lessons time). Ideally there should be light volume on the second candle and high volume coming out of pattern - on the reversal candle confirmation.

Long Shadow, Small Body Reversal Signals

The long shadow candlesticks consist of one long shadow a small body (less than ½ the length of the shadow) and a small 2nd shadow (or no 2nd shadow). There are 4 main long shadow candlesticks – The Hammer, Hanging Man, The Inverted Hammer and The shooting star. The Hammer and The Hanging Man both have long lower shadows and can have filled or hollow bodies, while the Inverted Hammer and Shooting Star have long upper shadows and also have filled or hollow bodies. The longer the shadow is, the more relevant the potential reversal.  All 4 can be doji. As with all candlestick patterns it's better not to take them in isolation - a prior trend needs to be present and there needs to be subsequent confirmation.

In the below charts we can see examples of these long shadow reversals. These reversal signals will need further confirmation in the shape of a good reverse candle or a gap to the reverse.  Further technical analysis, like volume (as we'll explore below) will also be helpful.  We'll also discover in further sections that these signals can also confirm support and resistance areas

Long Shadow Reversal Signals

The Hammer and Inverted Hammer are bullish in reversal after a decline in trend and can signify support. 

The Hammer - sellers have driven prices down before buyers came back into the market to force the session higher. This signifies demand and supply are almost in balance at the end of the period, but a potential reversal maybe due after a bull charge. Another way of looking at it is, The Market has rejected these current lower prices for the moment, with demand increasing at higher prices. There is indecision in the market! Further confirmation with a subsequent bull candlestick or jump up is needed to confirm this reversal.  This confirmation is needed because as the low of the shadow shows, plenty of sellers remain in the market.  

Ideally volume should increase on the day of the hammer and the longer the wick the better - both bring an increased chance of reversal.  Also, increased volume on the next candle confirmation is needed. Although the body can be hollow or filled, a hollow body brings slightly more bullish implications

The Inverted Hammer indicates buying pressure during the session, but bears eventually won the day driving price back down. Again, there's indecision in the market, bears are still in the market and bulls are definitely present, so further price action to the upside in the next trading session can confirm a bullish reversal. Also, higher volume on the inverted hammer increases the chances of the reversal, especially if we get a reversal confirmation next period (also with higher increased volume). Although the body can be hollow or filled, a hollow body brings slightly more bullish implications

The Hanging Man and The Shooting Star are bearish indicators

The hanging man, sellers pushed prices down during this session before bulls recovered, driving price higher. A flag has been thrown, which indicates a near supply/demand balance at the end of the period and a possible reversal. To beat this indecision, further price confirmation is required to call this a bear reversal, such as a long filled candle down or gap down.  
Increased volume on the reversal confirmation candle is also needed. High volume is also important on the hanging man day - meaning that traders who bought that day will be stuck with losing trades if the signal is confirmed the next day. Although the body can be hollow or filled, a filled body brings slightly more bearish implications

The shooting Star opens the session with prices advancing, but bears take hold and drive price down. The ability for these bears to bring price down indicates a potential bearish reversal, but once again there's indecision in the market (surprise!). Confirmation is seen with a following long bodied bear candlestick or gap down.  

Ideally volume should increase on the day of the shooting star and the longer the wick the better - both bring an increased chance of reversal. Also, higher volume on the next candle confirmation is needed. Although the body can be hollow or filled, a filled body brings slightly more bearish implications

The Spinning Top

A Spinning Top is a candle where it's shape has a small body with upper and lower shadows of equal length, but with greater length than the body. The spinning top also indicates a reversal after a trend. Again, we require confirmation of the reversal with a subsequent reversal candle of gap up or down.candle. If there's not confirmation then the candle means very little. The candle can be hollow or filled, but greater emphasis can be placed on hollow (or green) for a bullish reversal and filled (red) for a bearish reversal.

Spinning Top Reversal Candlestick Pattern
The Spinning Top Candlestick

Here, buyers and sellers had various parts of the trading session, but in the end the open and close were relatively close. Also, the spinning top's price action may be contained within a tight range. These two factors indicate indecision, or balance and a possible reversal. If we find the spinning top (or any long shadow/doji candle) in a range we can ignore it, as it’s just confirming the ranges indecision. You may find spinning top's with longer shadow's and small bodies. If this is the case then you may want to treat them like "Long-Legged Doji". With regard to volume, you really want to see increased volume on the reversal confirmation candlestick. You may also see increased volume on the spinning top itself.

More...


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Previous...


Introduction

As mentioned in “Candlesticks The Basics” certain candlesticks have reversal implications dependent on where they sit in a chart - only further confirmation candlesticks (i.e engulfing candles) determine the reversal propositions. In the following section we’ll talk about the most common candlestick patterns and how they go on to form reversal patterns.  All have similar reversal properties, but The Doji reversal should be considered the more robust – or at least a near doji (open and close very near). You'll find a common thread in them all - Market Indecision.

When traders use price action to form their trading strategies the reversal must have further confirmation. Candlesticks are regarded as neutral, bullish or bearish, so need this further confirmation to signify a reversal – otherwise they just form support and resistance levels (which is useful in itself), or confirm a “continuation pattern” in the trend. The actual reversal indicates that buyers/sellers overcame prior selling/buying pressure and we'll discuss this confirmation below. You'll also learn in the following paragraphs that some candlestick patterns consist of 1, 2 or 3 candlesticks, so let's discuss this further...

The Star Position Pattern (3 Candles)

The Star Position Pattern is a reversal pattern, made by two candles and a reversal confirmation candle -  a long body, a short body that gaps beyond the first candle (up or down depending on the prevailing trend). It then needs a reversal confirmation.  We can see this at work in the below chart where the star in a down trend is called the morning star and in an up trend it's called an evening star.

Morning and Evening Star
The Star Position Reversal Pattern

The star candle gaps up or down from the preceding candlestick.  The preceding candlestick will usually have a long candle body, while the star candle will have a small body indicating indecision on where the market is going. The star can be filled or hollow in a bearish or bullish trend reversal. Doji, hammers, shooting stars, spinning tops all have small bodies and can be seen in the star position (See Candlesticks - The Basics for definitions). After the star candle there must be a reversal candle to complete the confirmation.  This star position isn’t easy to find, so pay special attention to it when it happens. Volume plays it's part in the reversal. Ideally there should be reducing volume going into the star and increased volume on it's reversal confirmation candlestick. Pay particular emphasis on the volume of the confirmation candlestick.

The Morning & Evening Doji Star Reversal Pattern

As stated in “Candlesticks - The Basics”, Doji on their own only indicate buyers and sellers are balanced or that price action is limited with indecision. The Morning and Evening Doji Star Reversal is just another version of the Star Reversal Pattern above, but maybe more meaningful. The real relevance of doji depends on the preceding trend or candlestick and it's reversal confirmation. A doji in a ranging market doesn’t tell us anything other than indecision. However, after a trend or after a long candlestick the doji signals that the trend is starting to weaken and price momentum may reverse

Morning and Evening Doji Reversal
The shape of the doji may differ during the reversal, i.e. in our above example the cross and inverted cross may be switched for any Doji as highlighted in Candlesticks - The Basics - (common, long-legged, dragonfly, gravestone, cross and inverted cross are all interchangeable) . When looking for the reversal patterns chartists look for a Doji (or a short body candle at the very least) after a trend then require there to be a reverse confirmation candle (or gap up or down depending on the previous trend). The 3rd candle needs to extend at least half way through the 1st candle for the reversal to be robust. Both the Morning Doji Star and Evening Doji Star are charted above.  Basically, trend activity is interrupted by indecision, leading to a reversal. The forces of supply and demand are starting to equal out at the quoted price and a reversal may be about to occur. Once again, further technical analysis and increased volume on the confirmation candle (3rd candle) is needed to verify any reversal. It's also better to see reduced volume on the the 1st candlestick. 

The Harami Position Pattern

The pregnant woman (Japanese translation "Harami") is also a reversal pattern and is more common than the star position. Basically it is two candlesticks, plus a third candlestick confirming the reversal - the 1st being a long bodied candlestick, the 2nd body nestling within the body of the 1st and the 3rd confirming the reversal. This is graphically represented in the below chart.

The Harami Position Reversal Pattern

The shadows of the 2nd candle don’t have to be confined within the 1st candles body, but it helps. This is a bullish or bearish reversal depending on the previous trend and can be formed by either a hollow or filled body in any combination (The 2nd candle in a harami can also be a doji candlestick). The close of the Harami in a bullish pattern (indicated above) must be higher than the close of the longer filled candlestick. A bullish Harami will be found at the bottom of a downtrend. Bearish is the exact opposite and found at the top of an up trend. 

Saying that the Harami can come in any combination of hollow or filled is true, but a Harami with a hollow 1st candle is considered more bullish and a Harami with a 1st filled candle is considered more bearish. This shows a sudden resurgence in buying/selling pressure prior to a consolidation, then the reversal. A Harami with a 1st filled candle can still be bullish if it’s found at the bottom of a down trend.  they also occur more often than the more bullish hollow 1st candle Harami. 

In our above example, The 1st filled candle indicates that there are still plenty of sellers in the market, but then a small candle that kicks up a little from the previous close indicates that buyers are waiting in the wings for a potential reversal (They may also believe this is an area of support - we'll explore this in a few lessons time). Ideally there should be light volume on the second candle and high volume coming out of pattern - on the reversal candle confirmation.

Long Shadow, Small Body Reversal Signals

The long shadow candlesticks consist of one long shadow a small body (less than ½ the length of the shadow) and a small 2nd shadow (or no 2nd shadow). There are 4 main long shadow candlesticks – The Hammer, Hanging Man, The Inverted Hammer and The shooting star. The Hammer and The Hanging Man both have long lower shadows and can have filled or hollow bodies, while the Inverted Hammer and Shooting Star have long upper shadows and also have filled or hollow bodies. The longer the shadow is, the more relevant the potential reversal.  All 4 can be doji. As with all candlestick patterns it's better not to take them in isolation - a prior trend needs to be present and there needs to be subsequent confirmation.

In the below charts we can see examples of these long shadow reversals. These reversal signals will need further confirmation in the shape of a good reverse candle or a gap to the reverse.  Further technical analysis, like volume (as we'll explore below) will also be helpful.  We'll also discover in further sections that these signals can also confirm support and resistance areas

Long Shadow Reversal Signals

The Hammer and Inverted Hammer are bullish in reversal after a decline in trend and can signify support. 

The Hammer - sellers have driven prices down before buyers came back into the market to force the session higher. This signifies demand and supply are almost in balance at the end of the period, but a potential reversal maybe due after a bull charge. Another way of looking at it is, The Market has rejected these current lower prices for the moment, with demand increasing at higher prices. There is indecision in the market! Further confirmation with a subsequent bull candlestick or jump up is needed to confirm this reversal.  This confirmation is needed because as the low of the shadow shows, plenty of sellers remain in the market.  

Ideally volume should increase on the day of the hammer and the longer the wick the better - both bring an increased chance of reversal.  Also, increased volume on the next candle confirmation is needed. Although the body can be hollow or filled, a hollow body brings slightly more bullish implications

The Inverted Hammer indicates buying pressure during the session, but bears eventually won the day driving price back down. Again, there's indecision in the market, bears are still in the market and bulls are definitely present, so further price action to the upside in the next trading session can confirm a bullish reversal. Also, higher volume on the inverted hammer increases the chances of the reversal, especially if we get a reversal confirmation next period (also with higher increased volume). Although the body can be hollow or filled, a hollow body brings slightly more bullish implications

The Hanging Man and The Shooting Star are bearish indicators

The hanging man, sellers pushed prices down during this session before bulls recovered, driving price higher. A flag has been thrown, which indicates a near supply/demand balance at the end of the period and a possible reversal. To beat this indecision, further price confirmation is required to call this a bear reversal, such as a long filled candle down or gap down.  
Increased volume on the reversal confirmation candle is also needed. High volume is also important on the hanging man day - meaning that traders who bought that day will be stuck with losing trades if the signal is confirmed the next day. Although the body can be hollow or filled, a filled body brings slightly more bearish implications

The shooting Star opens the session with prices advancing, but bears take hold and drive price down. The ability for these bears to bring price down indicates a potential bearish reversal, but once again there's indecision in the market (surprise!). Confirmation is seen with a following long bodied bear candlestick or gap down.  

Ideally volume should increase on the day of the shooting star and the longer the wick the better - both bring an increased chance of reversal. Also, higher volume on the next candle confirmation is needed. Although the body can be hollow or filled, a filled body brings slightly more bearish implications

The Spinning Top

A Spinning Top is a candle where it's shape has a small body with upper and lower shadows of equal length, but with greater length than the body. The spinning top also indicates a reversal after a trend. Again, we require confirmation of the reversal with a subsequent reversal candle of gap up or down.candle. If there's not confirmation then the candle means very little. The candle can be hollow or filled, but greater emphasis can be placed on hollow (or green) for a bullish reversal and filled (red) for a bearish reversal.

Spinning Top Reversal Candlestick Pattern
The Spinning Top Candlestick

Here, buyers and sellers had various parts of the trading session, but in the end the open and close were relatively close. Also, the spinning top's price action may be contained within a tight range. These two factors indicate indecision, or balance and a possible reversal. If we find the spinning top (or any long shadow/doji candle) in a range we can ignore it, as it’s just confirming the ranges indecision. You may find spinning top's with longer shadow's and small bodies. If this is the case then you may want to treat them like "Long-Legged Doji". With regard to volume, you really want to see increased volume on the reversal confirmation candlestick. You may also see increased volume on the spinning top itself.

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