Most traders fall into one of two categories: Those following the trend and those trying to predict a change in the trend. When trying to pinpoint a change in the trend, traders often use candlestick patterns to make high probability predictions. These candlestick patterns are visual representations of sorts for the market’s psychology at a given point in time and can be invaluable in predicting reversals.
In this article, we’ll take a look at some popular bullish reversal patterns and how traders can use them to identify profitable trend changes.
A bullish engulfing is a reversal pattern characterized by a small daily candlestick body followed by a day whose candlestick body completely “engulfs” the previous day’s candlestick body. The shadows or tails of the smaller candlestick are also completely “engulfed” by the larger candlestick in order for the pattern to be considered completely valid by market technicians.
The bullish engulfing pattern represents the bulls taking control of the market in a given security from the bears. After the pattern occurs, traders should watch for a rebound in the security’s price as a confirmation of the reversal.
Learn more about Trend Reversals: How to Spot and How to Trade.
A bullish harami is a reversal pattern characterized by a large candlestick followed by a smaller candlestick whose body lies within the scope of the larger candlestick body. As with the bullish engulfing, the shadows or tails of the smaller candlestick must also be within the scope of the larger candlestick in order for the candlestick pattern to be considered completely valid by market technicians.
The three-candlestick pattern suggests that the bears are ceding control to the bulls, as evidenced by their inability to maintain a strong downward trend. After the pattern occurs, traders should watch for a rebound as confirmation of a reversal.
A bullish hammer is characterized by a hammer-shaped candlestick consisting of a small body at the top of a longer shadow or tail. During the period, the security experiences a significant sell-off that creates a long shadow or tail, followed by a rally that causes the security’s price to closer near its opening price. The shadow or tail should be at least twice the length of the candlestick’s body.
In terms of market psychology, the bullish hammer pattern suggests that bears attempted to take the stock lower throughout the period, but failed to hold the security down from a late rally to close near its opening price.
Bullish Morning Star
A bullish morning star is characterized by a large bearish candlestick body followed by a small-bodied candlestick that closes below the first candlestick followed by a large bullish candlestick body that opens above the middle candlestick and closes near the center of the first candlestick’s body. The pattern usually indicates that a downtrend is likely to experience a near-term reversal.
Be sure to check out the 25 Stocks Day Traders Love.
In essence, the bullish morning star pattern involves bears taking control of a security and pushing it down, followed by a day of relative uncertainty, which is then followed by a strong move higher controlled by the bulls.
How to Trade Bullish Reversals
Bullish reversal patterns provide traders with an early indication of a potential change in a security’s underlying trend. Depending on the timeframe being analyzed, these candlestick patterns can represent short-term or long-term changes in prevailing trends. Traders should consider several factors, however, rather than blindly following these bullish reversal patterns.
Here are a few tips to keep in mind:
- Multiple Timeframes – Always look at an opportunity in multiple timeframes to confirm whether the reversal in the short-term goes with or against longer-term trends in a security’s price over time.
- Seek Confirmation – Always look to see if there are any other technical indicators that may provide confirmation of a trend change. For instance, a crossover in the MACD indicator could provide such a confirmation.
- Look for Volume – The greater the volume, the more significant the candlestick pattern, all else equal. Traders should look for reversals that occur on high volume as bulls and bears fight for control.
The Bottom Line
Bullish reversal patterns can provide a great early indication of a potential change in price trend, but traders should seek confirmations before acting upon them. By looking at multiple timeframes, seeking confirmation, and considering volume, traders can maximize the odds of finding winning trades.
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