Candlestick Reversal Patterns

REVERSAL PATTERNS
When it comes to investing or trading, identifying reversal patterns can be very helpful. That doesn't mean you should only pick tops and bottoms. It is nearly impossible to pick a top or bottom in a current trend. What reversal patterns can do is help you identify a significant change in the current market direction. For example, we saw the US dollar slide lower and lower. When will we see a reversal in this trend?

A reversal pattern could signal a possible end of the current trend or it could signal a continuation of the trend. There are two types of reversal patterns, bullish and bearish. A bullish reversal pattern will appear at the end of a downtrend and a bearish reversal pattern will appear at the end of an uptrend. A reversal of the current trend signifies that the selling or buying pressure subsided for that trading day. There are different ways to spot reversals. I prefer to use candlestick charts since, in my opinion, they reveal a very detailed representation of that trading day. From a visual standpoint, candlesticks are a great tool to help you spot one of these reversals once you learn to spot the formations.

THE COMMON REVERSAL PATTERNS
I will discuss some of the more common candlestick reversal patterns.

FIGURE 1: Here's the hammer, a bullish reversal pattern that forms after a decline.

But spotting the hammer pattern is not enough. You need some other confirmations in addition to this pattern to indicate a change in the current downtrend. After the hammer pattern is formed, you want to see a continuation of buying with strong volume to really signal a change. The long thin line on the hammer is what is most important because it tells you that the sellers are still there. Seeing the hammer formation cannot be used as a signal by itself.

What you need to look for:

FIGURE 2: Here's the hanging man, a bearish reversal pattern that may signal the end of the current uptrend.

What you need to look for:

FIGURE 3: And the spinning tops pattern shows indecision between the bulls and bears.

Oftentimes, this pattern forms after a current long trend. This signifies that there could be a reversal in that trend. For example, after a long advance or a series of strong candlesticks, seeing a spinning top tells you that selling pressure is starting to gain momentum and may lead to a reversal of the strong buying. On the other hand, after a long decline or filled in candlestick (usually black) a spinning top can indicate that the selling pressure is subsiding and this could potentially signal a trend reversal.

A spinning top alone is not a signal of a reversal. You need to get confirmation before you can make a trading decision based on spotting a spinning top. However, the spinning top is a good indicator that the current trend is starting to lose momentum and a possible reversal could occur.

Once you learn to identify one you will be able to identify the other easily. It is important to keep in mind that identifying the pattern is only the first step. The next depends on you as an investor and your investing philosophy. That means you will have to decide when to pull the trigger on the trade based upon these patterns. Learning to find formations using candlestick patterns can give you the edge when trading.