Candlestick patterns provide great insights into market psychology without the subjectivity associated with many forms of technical analysis. In particular, candlestick patterns excel at predicting short- and long-term tops and bottoms without having to look beyond a few price bars. Candlestick patterns are best used in conjunction with other forms of technical analysis that confirm long-term trends.
In this article, we’ll take a look at some common bearish reversal patterns and how they can be used in everyday trading to increase the odds of success.
Be sure to also see our Visual Guide to Bullish Reversal Patterns.
The bearish engulfing occurs when a small white candlestick with short shadows (or tails) is followed by a large black candlestick that completely “engulfs” it. Often times, the pattern occurs after a bullish move higher and predicts a bearish move lower and change in the prevailing trend. The pattern has a tendency to correctly predict downturns, but the breakdowns can be somewhat short-lived in nature.
Be sure to read more about Trend Reversals: How to Spot and How to Trade.
The bearish harami occurs when a large candlestick is followed by a much smaller candlestick with a body located within the vertical range of the larger body. Often times, the pattern occurs when a previously bullish trend is drawing to a close and a bearish trend may be ready to take its place. The pattern isn’t as reliable as the bearish engulfing but is still worth analyzing in context.
Bearish Evening Star
The bearish evening star is a three-candlestick pattern that occurs when there’s a large bullish candlestick, followed by a small candlestick that closes above the first candlestick’s bar, followed by a large bearish candlestick that opens below the middle candlestick and completely or nearly erases the first candlestick’s gains. In general, the pattern tends to be a good predictor of bearish reversals.
Bearish Shooting Star
The bearish shooting star looks exactly the same as an inverted hammer candlestick, with a small lower body, little or no downward tail, and a long upward tail. Unlike the inverted hammer, the candlestick pattern occurs in an uptrend rather than a downtrend, predicting a bearish reversal. A longer tail indicates a greater potential for reversal, although traders should seek confirmation with the pattern.
Bearish reversal patterns can provide great insights for traders, but it’s important to remember their shortcomings. While they are great for predicting quick reversals, traders should use other forms of technical analysis to confirm the overall long-term trends before using them. For example, looking at multiple timeframes can help determine the short-term and long-term trends for a given security.
For example, suppose that a trader identifies a stock in a long-term uptrend that appears to be topping out. He or she may use Relative Strength Index to determine that the trend is losing steam, while confirming the bearish sentiment with a Moving Average Convergence/Divergence crossover. In this case, a bearish engulfing may provide a specific trigger for a short sale.
The Bottom Line
Candlestick patterns provide a great way for traders to determine potential trend reversals. In particular, bearish engulfings and bearish evening stars provide high-probability trend reversal indicators, although bearish shooting stars and bearish harami may also provide some useful insights. Traders should keep in mind, however, that these tools are best used in conjunction with other forms of technical analysis in order to improve the likelihood of a successful trade.