All You Need To Know About Candlestick Terminology And Market Emotion

What You Need To Know About Reversal Patterns

Technicians will watch for the price clues which often alert them when shifts occur in market trends and psychology. The reversal patterns are described as technical clues.

The Western reversal indicators are inclusive of double bottoms and tops, island bottoms and tops, head-and-shoulders, and reversal days.

Yet the actual term that is known as “reversal pattern” is regarded as one of the misnomers. When you hear this term it might lead you into thinking that this means the abrupt end of an “old” trend that reverses into a “new” trend. Yet this is very rare. Instead, the trend reversals typically occur in stages and very slowly and underlying psychology starts to shift gears.

The signal for trend reversals is an indication that a previous trend will more than likely change, yet it doesn’t always mean that it will reverse. This is vital to understand. You can compare an uptrend to this example: there is a car that is traveling in a forward direction at 30 m.p.h. The red brake lights of the car go on, where the car comes to a stop. The brake light is described as a reversal indicator which shows that the previous trend (in this case, the car moving forward) is about to come to an end. From here the car has stopped, but is the driver going to start reversing? Will he remain stationary? Or will the driver start moving forward again? Without any more clues, it is difficult to know.

There are few examples of what might happen once a top-reversal signal appears. The previous uptrend, for example, could change into the period of a sideways-price action. Then the opposite and new trend lower might start. (See Exhibit 4.1).

Here we can indicate how an “old” uptrend could resume. This shows the way in which an uptrend could reverse abruptly into the downtrend. It is practical to think of the reversal patterns as types of trend-change patterns. In fact, I was thinking of using the term “trend change patterns” rather than “reversal patterns” in this book. However, to make sure things remain consistent I decided to stay with reversal patterns.

Top Reversal, and for technical-analysis literature, I made a decision to keep the term “reversal patterns”.

Keep in mind that when you see the word “reversal patterns”, it is an indication that the previous trend is about to change, but it doesn’t always mean that it will reverse. Recognizing when reversal patterns start to emerge is regarded as a useful skill. Successful trading involves having probability and the trend in your favor.

Reversal indicators should be seen as the market’s method to provide road signs, like “Caution- Trend In Process of Change”. And to put this into other words, the psychology of the market is under transformation. It is wise to adjust the way you trade or your style to reflect any new and upcoming market environments. There are several methods to trade out of and in positions with the reversal indicators. We will be discussing these throughout this book.

One of the important principles involves placing your new position (according to the reversal signal) only when the signal is in fact in a direction associated with this major trend. Let's use this example: In a Bull Market, a top-reversal pattern has emerged. This is a bearish signal that does not warrant the need for a short-sale. This has to do with that the major-trend happens to be still up. It does, however, indicate a liquidation of the longs. If on the other hand there happened to be a dominant downtrend, the same top-reversal formation can then be used in order to place a short sale.

I have discussed this subject of Reversal Patterns in detail, as the majority of the Candlestick indicators happen to be reversals. Now I will give you more information about the 1st group of the Candlestick Reversal Indicators, which include the hanging-man and hammer lines.

Hanging-Man And Hammer Lines

Here we display candlesticks that have small and real bodies along with lower and long shadows. These real bodies are close to the top part of a daily range. The different candlestick lines displayed in this exhibit happen to be highly interesting in the way that either of these lines can be bearish or bullish dependent on where they emerge in this trend. If any of these lines appear over a downtrend, it is an indication that this L downtrend should be coming to an end. In this situation, the line will be labeled as a hammer.

When “the market is hammering out” a base,It is of interest, that the Japanese word for the line is “takuri”. This word can be described as “ trying to gauge the water depth by feeling for its bottom”.

If any of the lines in appearing after the rally it is an indication that the previous move might be ending. These types of lines are known as the “hanging man”  This name was given because it appears like a man that is hanging along with dangly legs.

It might sound unusual that this type of candlestick line could be both bearish and bullish. Yet for people familiar with Western Island bottoms and tops, you should recognize that an identical idea will apply here.

The Island formation will be either bearish or bullish dependent on where it emerges in the tend. An Island after an uptrend that is prolonged will be bearish, while this same Island pattern after a prolonged downtrend will be bullish.

The hanging man and hammer are recognizable according to three criteria:

1. The Real Body is situated close to the upper-end of a trading range. The color associated with the Real Body is not of importance.

2. The lower long shadow is double the height when compared to the Real Body.

3. It will have either an extremely short, or no upper shadow.

The lower shadow that is longer, means the upper shadow will be shorter, and the Real Body becomes smaller the more the bearish hanging-man or the bullish-hammer becomes meaningful. Even though the Real Body of either a hanging man or hammer can be black or white, it becomes a bit more bullish when the Real Body of the Hammer happens to be white, or a bit more bearish when the Real Body of the Hanging Man happens to be black.

When the Hammer’s Real Body is white this is an indication that the market has sold off very sharply over this session followed by bouncing back near or close at the high of the session. This could result in bullish ramifications. When the Real Body of the Hanging Man is black, this displays that the actual close was unable to return to the open-price level. This could result in bearish implications.

It is very important to wait for a bearish confirmation when it comes to the Hanging Man. The logic behind this is associated with the way the Hanging-Man line generates. In most cases, in this type of situation, the market will be filled with bullish energy, and then a Hanging Man will appear. On the Hanging-Man day, the market will open near or at the highs, followed by sharply selling off, where it then rallies near or close to the highs.

This is a price action type that will start to emerge as the market has started to sell-off, making it vulnerable to fast breaks. However, it may not be a price action type that may lead you into thinking that the Hanging Man might actually be a Top Reversal.

Yet, should the market open lower on the following day, people that bought on either the close or open of the Hanging-Man day will now be left “hanging” in a losing position. For this reason, the broad principle about the hanging-man is that when the down gap gets greater between the Real Body of the Hanging-Man Day, along with the opening that occurs on the following day, it is more likely that the Hanging Man will be at the top. One of the other bearish verifications could include a black Real Body session where the close is lower than that of the Hanging Mans sessions close.