Candlestick reversal patterns are patterns formed on a chart using candlestick analysis charting. The formations created by plotting the relevant stock prices (high, low, open and close) provide indication that a reversal in trend is likely to be on the cards. There are many different types of reversal patterns, but they can be broadly classed into two categories; bullish reversal patterns, and bearish reversal patterns.
Bullish reversal patterns signal that a prevailing downward, or bearish, trend is likely to experience a period of upward, or bullish, movement. The reverse also applies, in that a bearish reversal pattern indicates the probability that a downturn during a bullish upward trend is imminent.
Validity of Candlestick Reversal Patterns
Candlestick reversal patterns are an effective short-term reversal indicator. The formation of these patterns during a trend does not necessarily mean a complete reversal, but often, a temporary change in price direction.
In order to qualify as a genuine reversal signal, there are some criteria that must be met. Firstly, there must be an established trend in the opposite direction of the pattern. If the pattern occurs in the same direction as the trend it could be considered a continuation pattern.
Most types of candlestick patterns require confirmation to be considered a valid reversal indicator. One form of confirmation can be found in the candlestick immediately following the pattern. Other methods of technical analysis are recommended as a means of verifying candlestick patterns. Indicators signaling increased momentum provide credibility to a bullish reversal pattern, and decreased momentum supports a bearish reversal.
Different Candlestick Patterns
There are numerous different candlestick reversal patterns, and they are formed by one or more candlesticks. Here are a few of the most popular types of reversal patterns:
- The Engulfing pattern is formed by two candlesticks. The first is a short candle, indicating a narrow trading range for the period, and the second is a tall candle of the opposite color. The short candle shows a weakening of the momentum of the trend, and the tall candle signals a strong move in opposition. In the case of a bearish trend, this candle will be black, indicating a lower closing price. The second candlestick is a tall candle which means the price range was wide for this period. Signaling a bullish reversal in a bearish trend, this candlestick will be white, showing a high closing price. The opposite applies to a bearish reversal pattern during a bullish trend. The first candlestick will be short and white, portraying a narrowly higher closing price, and the second will be tall and black, showing a wide range and a low close.
- The Harami pattern is basically the opposite of the engulfing pattern, and indicates that the preceding momentum has petered out. The pattern consists of two candlesticks. The bullish harami is comprised of a tall black candle followed by a short white candle. The bearish harami depicts a tall white candle preceding a short black candle.
- The Doji is a single candlestick pattern that appears basically like a cross, with a flat line for the body of the candlestick. This means that the opening and closing price were the same, or almost the same. The implication of this is that there is indecision and questioning of the trend, which will often trigger a reversal.
Candlestick reversal patterns may provide valuable insight into the likelihood of an imminent reversal in trend. This is especially true when the patterns are confirmed by a subsequent candlestick, and an accompanying change in momentum.