If you watch Apiary Fund trading sessions, one thing you will see is that Shawn Lucas can trade a reversal really well. With reversals being one of the two primary profit makers for traders, alongside continuations, knowing how to spot reversals is pivotal in trading. There are so many ways either via patterns of multiple candles or just single-candle formations that let you know when a reversal is more or less likely. Here are a few of the most common reversal patterns and what they mean.
Overbought and Oversold Markets
Using technical indicators such as the RSI or Stochastic indicator can give a great picture of the market being overbought or oversold. Once a market is overbought of oversold, it can only sustain that strength and direction for so long. Once that strength fails to continue upholding itself, a reversal is set to ensue. This reversal is typically pretty easy to spot as 1) the RSI or Stochastic indicator will have peaked and began to reverse, and 2) the market will start forming the opposite candle type (bullish or bearish) of what was previously forming.
Shooting Stars and Hammers
Shooting stars and hammers are both similar in their aesthetic with the difference being the direction in which the wick forms. Both are candles with long wicks and a relatively close open and close price. A longer wick on the bottom signifies a hammer, represented by the handle on the bottom with the hammer head on top. If this is in a downward trend, it commonly shows a reversal. This is because the pattern continued down, then that one candle started to reverse which formed that long wick. A shooting star is represented by the longer top wick which resembles the tail on a shooting star heading down toward Earth. If this is at the top of an upward trend, it commonly means a reversal for the same reason as the hammer, a continued pattern with the directional change being able to be seen on one candle.
An engulfing candle is a candle in the opposite direction of and that is larger than the previous. Engulfing candles usually signal the start of a pullback or a full reversal. Once you see that the current, or close price, of the current candle is higher or lower than the open of the previous candle (accounting for opposite directions) and that if you shifted the current candle to the left, it would completely cover the prior candle, you can enter the reversal trade. Engulfing candles are one of the least reputable indications of a market reversal that you can catch, however, so be cautious when trading these.
Along with these types of reversals, Apiary Fund trading sessions, and looking at previous posts, namely the “How to Identify Trends in the Forex Market” and “Explaining Reversal Breakout” articles will all give good ideas of what to look for when it comes to reversals and how to trade them. Reversals have more telltale signs of happening opposed to continuations which could reverse at any moment. Be on the lookout for reversal indications and happy trading.