Top 5 Forex Chart Reversal Candlestick Patterns
Updated: Apr 18, 2019
Timing when to enter and exit markets is one of the most challenging parts of Fx Trading.
Timing entry into new trends is an art but, if it can be mastered, it can yield the most profits. One of the most effective ways to do this is by predicting when price is about to reverse on a chart and then entering the trade in accordance with the new direction. Luckily, a technique known as candlestick analysis, which has its routes in ancient Japanese rice trading, can aid Forex Traders in doing just this.
These candlesticks or candlestick patterns appear at various points on all charts, however, they are the highest predictors of price reversal when found at the bottoms or tops of strong price moves.
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Today, I want to introduce you to the top 5 candlestick patterns for predicting price reversals.
Let's get started...
1. Evening Star And Morning Star
The Evening and Morning Star candlestick patterns are bearish (price decrease) and bullish (price increase) respectively. They each consist of three candles and are widely acknowledged to be around 72% accurate in predicting a price reversal.
The Evening Star:
1. The first candle is a bullish candle and is found at the top of an uptrend.
2. For the pattern to be valid, the second candle must gap higher (or must open higher than the high reached by the previous bullish candle). The body is very short or even flat as buyers fail to push the price higher.
3. The pattern is completed by a third candle, gapping lower, then sellers pushing the price down to form a bearish candle. The longer the body - the stronger the downward move
The Morning Star:
Simply a mirrpr of the Evening Star and a predictor that price will reverse and start to rise higher (become bullish).
Again, the longer the body of the third and final candle the more likely it is that price will rise - giving traders an indication of their likely upside!
2. Hammer and Hanging Man
The hammer and hanging man are bullish and bearish indicators respectively. If these candle stick patterns appear at major levels, then they are considered very strong indicators of a price reversal. Interestingly, there seems to be some disagreement over whether a top wick (line extending from the top of the candle) invalidates the signal or not - We suggest that , if there is a top wick, it should be as small as possible but better for there to not be one at all.
1. Has to be found at the bottom of a price decrease to be valid.
2. Price has been decreasing as sellers have been winning over buyers. Sellers managed to push price lower, then were overpowered by buyers, forming the "handle" of the hammer.
3. There is disagreement over whether a top wick invalidates this signal or not. We have seen a reversal with both, however, the longer the top wick the less sharp the reversal seems.
Exactly the same shape as the hammer and the same rules apply to validate or invalidate the signal.
Sellers failed to push price lower but buyers have run out of steam - a change of direction may be afoot.
However, this candlestick must be found at the top of a price increase to be valid!
It should also be noted here that the tail, in the case of both candlesticks, must be at least twice as long as the body for the signal to be valid.
3. Inverted Hammer And Shooting Star
Much like their mirror images, the hammer and hanging man, these two signals can be bullish or bearish respectively. Again, when appearing at major levels and after a strong bullish or bearish movement, these two candlesticks can be very strong indicators of a price reversal. The top wick is again a subject of debate but we reiterate that a small as possible top wick can still lead to an indication of price reversal - without, however, is a stronger indication.
1. Must be found at the top of a price increase to be valid
2. Sellers have been pushing the market lower, buyers then initially managed to win over and push the price higher before sellers then came back in and pushed price lower.
3. The formation shows that more buyers have come into the market and, although are currently evenly matched with buyers, the balance could soon change and, as a result, price may increase.
In contrast to the inverted hammer, a bearish signal. Found at the top of a bullish move, the formation represents the buyers losing momentum, sellers entering the market and then sellers increasing and thus pushing price lower.
Note, in the case of both candlesticks, the wicks must be at least twice the length of the body of the candles in order to be valid.
4. Bullish And Bearish Engulfing Candle
A very strong signal in both cases for the reversal of price action. They each consist of two candles and must be found at ends of their respective price actions, and at major levels, in order to be indicators of a price reversal.
Bullish Engulfing Candle
1. The pattern must be found at the bottom of a price decrease (bearish price action)
2. The first candle should be the final candle of the price decrease and must, therefore, be a bearish candle.
3. The second candle's body must completely "engulf" the body of the first candle - note that it is not important if it engulfs the wicks of the previous candle - although, this could be considered a stronger bullish signal.
Bearish Engulfing Candle
The opposite to the bullish candle, this pattern should be found at the top of a price increase in order to be valid.
In the case of the bullish engulfing candle the buyers have manged to take over and then overwhelm the sellers which is what makes this such a strong bullish signal.
The reverse is also true for the bearish engulfing candle.
A doji can be bullish or bearish, depending on whether it is found at the bottom of a price increase or a price decrease. Note, for a strong reversal to take place on the formation of a doji, the preceding price action should be strong i.e. strong bullish candles or strong bearish candles.
1. Formed because of an equal number of buyers and sellers in the market and thus associated with indecision or exhaustion.
2. The opening and closing price are the same, over the time period that the candle is representing, and so we end up with a flat line, making the candle look like a cross.
3. The fact that this candle represents that either buyers or sellers, depending on which price move the candle is found at the end of, have failed to continue the trend mean that this candle is a strong indicator that a reversal may occur. However, it should be noted that for confirmation of this, the next candle should be strongly in the opposite direction to the candles preceding the doji.
There are several more variations of the doji candlestick which, depending on their formation, can indicate a reversal into bearish or bullish price movement.
These are just a few of the many candlesticks and patterns there are that can really give you an edge in your Fx Trading by predicting a potential price move.
However, we recommend that this should be used as part of a wider strategy and should be combined with levels, trends and trading psychology.
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