Technical analysis studies price patterns and predicts future performance based on them. You can find chart patterns and candlestick patterns in trading. In addition, there are bullish, bearish, continuation and reversal patterns.
In modern trading, Japanese candlesticks are the main form of charting. The candlesticks were developed in Japan. And it’s obvious how this charting method got its name. The candlesticks were initially used to trade rice. Later they became highly popular in trading financial markets.
Japanese candlesticks offer much more information packed in a small amount of space than older traditional lines. The candlesticks display open and close prices and the highest and lowest points that were reached by the price within given candles. The candles let analysts better understand the psychology behind market moves.
There are various candlestick patterns developed using the Japanese candlesticks and we’ll discuss the most common patterns in this forex reversal candles guide. What’s more, we’ll show you how to trade them properly.
Understanding forex reversal candles
Depending on the predicted price direction after they form, chart patterns are categorized into reversals and continuation patterns. Continuation patterns help trends continue. Reversal patterns predict the prices to reverse and start new trends.
Using forex reversal candles is especially valuable for scalpers and intraday traders. Scalpers take advantage of trading price swings. In addition, candlestick patterns can be combined with various indicators. Using reversal candlestick patterns can help traders join trends right from the beginning and they offer great risk to reward ratios.
Bullish reversal candlestick patterns
There are bullish and bearish reversal candlestick patterns. Bullish reversal patterns are formed at the end of a downtrend and predict the prices to start trending upwards. There are various bullish reversal patterns in technical analysis and we’ll discuss the most common ones.
Hammer is a very common bullish reversal chart pattern. The pattern gets its name from its shape. Typically the pattern has a shadow that is twice the size of its real body. Hammer is formed in a downtrend and signals that the price will start rallying upwards. The pattern shows that the bear pushed price downward, but bulls took the initiative.
In order to trade the pattern properly, you should always wait for the hammer to close and never get in a trade during its formation phase. Stop loss can be placed below the shadow. And the take profit target is not specified. It all depends on how strong the new trend can be.
Morning star is another bullish reversal pattern that forms in a downtrend. The pattern consists of three candles. After a downtrend, bears are in control but do not achieve much progress. Afterwards bulls take the initiative. After the third candle closes, the pattern can be entered in the long direction. Stop loss can be placed right below the Morning Star pattern.
Morning doji star
Morning doji star consists of three candles and looks very similar to the morning star. The only difference is that the middle candle is doji. And for this reason the pattern is considered stronger than the regular morning start. In general, doji represents indecision. And what could signal trend reversal better than an indecision at the end of a downtrend? Stop loss and take profits targets work similarly as in the previous patterns. After the third candle stops forming, a trade can be opened in a long direction. Stop loss can be placed under the doji candle.
Inverted hammer appears in a downtrend and predicts the price to start uptrending. The pattern consists of a single candlestick. Upper shadow is usually twice as large as a real body. In order to trade the pattern, you should wait for the candle to complete forming and close. You can open a position as the following candle starts forming. Stop loss can be placed under the pattern. Take profit is not specified as well. In general, traders use trend indicators and trendlines to keep following new trends and take as much rewards as possible.
Piercing line is one more bullish reversal pattern that appears in a downtrend. The pattern consists of two candlesticks. The first one is bearish and the second one is bullish. Both bodies should be long enough. The pattern represents a shift in initiative. After the second candle stops forming and closes, the trade can be entered. Stop loss can be placed right under the pattern. And as in other cases, the profit target is not specified.
Bullish engulfing pattern
Bullish engulfing looks very similar to Piercing Line. The only difference is that the second candle is larger in size and engulfs the previous one. As a result, the pattern is considered to be stronger than the Piercing Line. In order to trade the pattern the right way, you should wait for the second, bullish candle to be closed. As the following candle starts forming, you can join the new trend and place stop loss underneath the pattern.
Three white soldiers
Three white soldiers are strong bull signals and they can signal trend reversal as well as trend continuations depending on the period trend direction. Three white soldiers consist of 3 large bullish candlesticks. The pattern predicts the price to keep trending upwards after the third candle closes. Stop loss can be placed beneath the first candle and the potential take profit target depends on the strengths of an uptrend.
Bearish reversal patterns
We’ve discussed various bullish reversal patterns. Now let’s take a look at bearish ones. In most cases, bullish and bearish reversal patterns mirror each other. They are similar in every way but reversed.
Shooting star appears in an uptrend. It consists of a single candlestick. Upper shadow is larger than the candle’s real body by at least twice. The pattern shows that bulls tried to reach new highs but bears managed to get prices down. After the candle is completed, a trade can be opened in a short direction.
Evening star pattern
Sometimes the evening star pattern has gaps but it’s not a must. The pattern consists of three candlesticks. The first one shared the prior trend’s sentiment and is bullish. The second candle is smaller in size and signals indecision. The third candle is bearish. After the third candle is fully formed, we have the evening star pattern ready. Traders can go short and place stop loss orders over the pattern.
Evening doji star
Evening doji star looks like the evening star candlestick pattern, but it’s considered to be stronger. As we’ve already mentioned, doji is generally viewed as a sign of indecision. The pattern consists of 3 candlesticks. In order to join a trade, the trader needs to wait for the third candle to close. Trade direction is short and the stop loss target is above the pattern.
Hanging man appears in an uptrend and signals trend reversal. The pattern consists of a single candle. The candle has a shadow that is at least twice the size of its real body. Traders should wait for the pattern to complete forming. In other words, the candle needs to fully close before considering joining the trade. Hanging man can be in both colors, however, red is a stronger signal. Traders can place stop losses above the pattern.
Bearish engulfing pattern
Bearish engulfing pattern is very similar to the bullish engulfing pattern, but reversed. The pattern appears in an uptrend. Bearish engulfing consists of two candlesticks. The first candle is green and bullish. The second candle is red and bearish. The red candle completely engulfs the first candle and signals potential price reversal downwards. It’s important to wait for the candle to fully close to enter the trade. Stop loss can be placed above the pattern.
Three Black Crows
Three Black Crows are very similar to the Three White Soldiers, but reversed. The pattern consists of three large candles that are predicting price to start moving downwards after the third candle closes.
Using forex reversal candles
In general, patterns work better in higher time frames. For example, if you are trading 1 minutes candle charts, candlesticks patterns might produce lots of false trading signals due to market noise. One of the reasons why patterns tend to work is that traders believe they work. As a result traders avoid placing orders against patterns and trading becomes a self-fulfilling prophecy. There are not many traders that are analyzing 1 minute chart patterns. And therefore higher the timeframe, the better.
Candlestick patterns are purely technical, which means that they do not take into account fundamental data when providing trading signals.
In order to trade candlestick patterns the right way, it’s important to wait for the candles to finish forming and not rush in. The reason is simple, the price might reverse and never finish the pattern. In addition, some traders wait for the following candle to close after the pattern candles are fully formed. The following candles are confirmation candles. And as the name suggests, they confirm the trade direction which was predicted by the patterns. The obvious downside is that once you enter the trade after the confirmation candle, a large portion of the price might have already been changed.
The main takeaways
To sum everything up, Japanese candlesticks are very popular and Japanese candlestick patterns are highly consumed in technical analysis. There are bullish and bearish candlestick patterns. In addition, there are patterns that predict prices to keep moving in the prior trend direction, and they are called continuation patterns. And there are reversal patterns that help prices reverse. Among the most popular reversal patterns are: Hammer, Morning star, Morning doji star, Inverted hammer, Piercing line, Bullish engulfing pattern, Three white soldiers, Shooting star, Evening star, Evening doji star, Hanging man, Bearish engulfing pattern and Three black crows. In order to properly trade candlestick reversal patterns, you should wait for them to fully form. Unfinished patterns may fail to finish and result in losing trades. Chart patterns are purely technical and it’s best to keep an eye on fundamentals when making trading decisions. In addition, keep in mind that patterns work better in higher time frames due to reduced market noise.
FAQs on Forex reversal candles in trading
What candle indicates a reversal?
There are various reversal candlesticks that indicate reversals. Keep in mind that each candlestick is either bullish or bearish. Some of the most common reversal candles are: Hammer, Morning star, Morning doji star, Inverted hammer, Piercing line, Bullish engulfing pattern, Three white soldiers, Shooting star, Evening star, Evening doji star, Hanging man, Bearish engulfing pattern, Three black crows.
How do you spot a candlestick reversal pattern?
Spotting reversal patterns becomes easy once you learn how they look. Through practice and hard work you will get more experienced in spotting them. What’s more, reversal patterns are easy to notice on the charts as they form at the top or at the bottom of a trend.
How to be sure that the reversal is taking place?
Reversal candlestick patterns help predict reversals when they are fully formed. In order to make sure that the reversal is taking place, you can wait for a confirmation candle. However, keep in mind that confirmation candles increase stop loss targets and reduce potential winnings.