How to Trade a Bearish Reversal
Identifying market trends and correctly predicting changes in them are essential for making better trading decisions. This enables you to enter or exit the market at the right time, maximising profits. Candlestick patterns not only help to identify trends but also trend changes or trend reversals. They provide trend reverse signals, which can be used to exit a current position or enter a new trade.
Before deciding to make your move, knowing that a reversal can be temporary is important. What if you were riding an uptrend, and the market changed direction only for a few hours before continuing the upward trajectory? If you hastily exited, you’d forgo profits. If you entered a short position, you’d end up making losses. To prevent such moves, you need to wait for a confirmation of the reversal. Here’s a look at how to identify a bearish reversal and what constitutes a confirmation.
Bearish Reversal Patterns
A bearish reversal is a sequence of patterns that indicate a potential change in the market from an uptrend to a downtrend. Such bearish reversal patterns are different from retracement, which refers to a temporary reversal of the uptrend, followed by a return to the original uptrend.
Only when a bearish reversal pattern is confirmed you can:
- Close out your long positions,
- Move up the stop losses
- Open short positions.
Types of Bearish Reversal Patterns
While there are several types of bearish reversal trends, here are the most common ones:
Bearish Shooting Star
This is a single candlestick pattern. This occurs during a bull run when a green candle has a small body, a long upper shadow, and a very small or no lower shadow. Also, the size of the upper shadow should be more than double that of the candle’s body.
This pattern is considered as confirmed, if the next candle is a red one, with a long body and short upper and lower wicks. When trading based on this pattern, experienced traders place the stop loss above the high of the shooting star candle.
Bearish Engulfing Pattern
This is a two-candlestick pattern. During an uptrend, when there are two candles such that the second one is red and is big enough to engulf the previous green candle. The bigger the second candle, the more bearish is the reversal.
This pattern is considered confirmed when the engulfing red candle is followed by another red one. Trading pros typically set a stop loss just above the high of the last green candle, when trading this bearish reversal pattern.
Bearish Harami Pattern
This pattern also includes two candlesticks. This pattern occurs when prices are increasing, and a red candle appears somewhere between the body of the previous green candle. The red candle must be small enough to be engulfed by the previous green candle.
if the price continues to decline, it’s considered a confirmation of the reversal. When trading this pattern, the stop loss can be set on top of the green candle.
Dark Cloud Cover
The dark cloud cover includes a green and a red candlestick, both with large bodies and small shadows. In an uptrend, when a red candle appears such that the open is above the previous close and the close is below the midpoint of the body of the green candle.
The appearance of the next red candle confirms this trend. The stop loss can be set higher than the top wick of the red candle in the pattern.
Bearish Abandoned Baby
This is a pattern formed by three candlesticks. During a bull run, this pattern occurs when a green candle is followed by the appearance of a very small red candle above the high of the green one, and then a long red candlestick below the low of the previous (small) red candle.
The appearance of subsequent red candles. You may place a stop loss just above the upper shadow of the small red candle.
Sushi Roll Bearish Reversal Pattern
To identify this pattern, you’ll need to look at ten candles. The first five candles of the series must display a narrow range of price highs and lows. These are called inside bars. The pattern includes another five candles that have a high variation in highs. These are the outside bars and must engulf the first five.
You can use tools like a ray to draw a breakout line or a rectangle tool to determine the size of the series of candles. When the last red candle is long with short wicks, it confirms the pattern.
Do This When Trading Bearish Reversal Patterns
No single pattern, even those using ten candles, should used as the only indicator of a trend reversal. It’s best to combine these candlestick patterns with technical indicators to confirm the reversal before placing an order.
While a bearish reversal pattern tells you that the bears (sellers) are gaining strength, it gives no indication of how intense the selling pressure is. This is what will finally determine whether the bears can gain control of the market and send prices in a downward trajectory. Momentum indicators, like RSI (relative strength index) or stochastic oscillator, give you a better understanding of the extent of selling pressure. Using these in combination with bearish reversal patterns can help you make a more informed decision.
To Sum Up
- Bearish patterns are signals of a possible reversal of an uptrend.
- You can use them to open short positions, close long positions and increase the stop loss.
- Some of the most common bearish reversal patterns are the bearish shooting star, engulfing pattern, harami pattern, dark cloud cover, abandoned baby and sushi roll.
- Always look for confirmation of the pattern.
- Use these patterns in combination with technical indicators to identify the extent of selling pressure.
- These candlestick patterns can also be used for placing stop loss orders when trading.
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