Prior Trend
For a
pattern to qualify as a reversal pattern, there should be a prior trend to
reverse. Bullish reversals require a preceding downtrend and bearish reversals
require a prior uptrend. The direction of the trend can be determined using trend
lines, moving averages, or other aspects of technical analysis.
Hammer and Hanging Man
The
hammer and hanging man look exactly alike but have totally different
meaning depending on past price action. Both have cute little bodies (black or
white), long lower shadows and short or absent
upper shadows.
The hammer
is a bullish reversal pattern that forms during a downtrend. It is named
because the market is hammering out a bottom.
When
price is falling, hammers signal that the bottom is near and price will start
rising again. The long lower shadow indicates that sellers pushed prices lower,
but buyers were able to overcome this selling pressure and closed near the
open.
Word
to the wise… just because you see a hammer form in a downtrend doesn’t mean you
automatically place a buy order! More bullish confirmation is needed
before it’s safe to pull the trigger. A good confirmation example would be to
wait for a white candlestick to close above the open of the candlestick on the
left side of the hammer.
Recognition
Criteria:
- The long shadow is about two or three times of the real body.
- Little or no upper shadow.
- The real body is at the upper end of the trading range.
- The color of the real body is not important.
The hanging
man is a bearish reversal pattern that can also mark a top or strong
resistance level. When price is rising, the formation of a hanging man
indicates that sellers are beginning to outnumber buyers. The long lower shadow
shows that sellers pushed prices lower during the session. Buyers were able to
push the price back up some but only near the open. This should set off alarms
since this tells us that there are no buyers left to provide the necessary
momentum to keep raising the price. .
Recognition
Criteria:
- A long lower shadow which is about two or three times of the real body.
- Little or no upper shadow.
- The real body is at the upper end of the trading range.
- The color of the body is not important, though a black body is more bearish than a white body.
Inverted Hammer and Shooting Star
The
inverted hammer and shooting star also look identical. The only difference
between them is whether you’re in a downtrend or uptrend. Both candlesticks
have petite little bodies (filled or hollow), long upper shadows and small or
absent lower shadows.
The inverted
hammer occurs when price has been falling suggests the possibility of
a reversal. Its long upper shadow shows that buyers tried to bid the price
higher. However, sellers saw what the buyers were doing, said “oh hell no” and
attempted to push the price back down. Fortunately, the buyers had eaten enough
of their Wheaties for breakfast and still managed to close the session near the
open. Since the sellers weren’t able to close the price any lower, this is a
good indication that everybody who wants to sell has already sold. And if
there’s no more sellers, who is left? Buyers.
The shooting
star is a bearish reversal pattern that looks identical to the
inverted hammer but occurs when price has been rising. Its shape indicates that
the price opened at its low, rallied, but pulled back to the bottom. This means
that buyers attempted to push the price up, but sellers came in and overpowered
them. A definite bearish sign since there are no more buyers left because
they’ve all been murdered.