High-Reliability Reversal Signals
Courtesy of Pharmboy
Chp. 9 of Pharmboy’s TA eBook (scroll down for links to Chp. 1 through 8)
Figure 63 shows four of the most highly-reliable reversal signals that every long should know charts: evening star, shooting star, bearish engulfing and bearish gap up.
Figure 63. Signals for reversals.
Evening Stars are one of the most reliable reversal patterns available as the failure rate is low. Evening stars suggest the rally is slowing because the open-close range decreases. The doji at the top signals an end to the rally and a struggle ensues between bulls and bears. This doji day is a critical candlestick. There is a very high chance that the stock price will drop the next day. Should that occur, the evening star pattern is confirmed, as a long white candle, the doji in the middle (or a large tail above a green, followed by a down red candle.)
Figure 64 shows two evening star examples [click on charts to enlarge]:
Figure 64. Evening star patterns.
Patterns will fail, so strict risk management and controls must be in place to handle failures, which is why TAers initiate small positions or wait for confirmation.
Shooting Stars is a favorite pattern to TAers. It was named by the Japanese rice futures traders as they noted it look like a star falling down to Earth. It’s an ominous signal that a stock price will drop. The failure rate is low, but higher than an Evening Star pattern. A shooting star day displays a gap up in the trading day, but for some reason is unable to hold its intra-day highs, and falls back near its close. From the open to its high, the shooting star is formed when at least 2/3rd’s of the day’s gains are gone. Figure 65 shows an example of a shooting star.
Figure 65. Shooting star.
Bearish Engulfing patterns are just as reliable as shooting stars, but not as reliable as Evening Stars. Still, bearish engulfing is a warning to traders that sentiment has almost entirely changed from the previous day. What happens here is that the first day opens and closes well over its open but on the next day, the stock gaps up and drops like a rock throughout the day and the open-close range penetrates so deep that it completely engulfs the previous day. This action basically cancels out the previous day entirely and shows that something happened that made investors/traders to dump the stock right after they bought it. Take a look at Verizon (VZ) below (Figure 66):
Figure 66. Bearish engulfing.
Another signature bearish pattern is the Bearish Belt Hold. These are stops that gapped up considerably but sold off throughout the day, closing well below its open. The gap is usually not filled on the same day. This pattern represents the ultimate change in extreme sentiment because investors/traders were excited, and the stock continues to be bought, even after-hours and pre-market the next day. The stock, though, falls back, and can move lower than before the jump. Figure 67 displays examples of the Bearish Belt Hold:
Figure 67. Bearish belt hold and examples.
Patterns fail, so cut losses QUICKLY if this occurs (Figure 68).
Figure 68. Failure of Bearish belt hold pattern.
Previous Chapters:
1. Understanding Market Cycles: The Art of Market Timing (Chp. 1),
2. Dow’s Theory of Markets (Chp. 2),
3 & 4. Fundamental vs. Technical Analysis and Types of Technical Trading (Chps. 3 & 4).
5. Stock Charting Basics: How to Read & Understand Stock Charts (Chp. 5 here.)
6. Using Moving Averages for Long and Short Trades (Chp. 6)
7. Basic Technical Patterns: The Foundation of Common Pattern Identification (Chp. 7)
8. Playing the Gap: Identifying and Trading Gaps (Chp. 8)
