What are trend reversals

A trend reversal implies that the prior trend is likely to change, but not necessarily reversing

Differences between Hanging Man and Hammer

1. Hammer comes after a decline, Hanging Man comes after a rally

2. Hammer is valid even from a short-term decline but Hanging Man should emerge after an extended rally, preferably at an all-time high

3. Hanging Man should be confirmed, Hammer need not be

#1 Hammer

A lower shadow of two or three times the height of the real body is necessary to show that the market has been pushed down sharply during the session, but the bears lost control and the market closed at or near its session highs. It is okay if the hammer has a little upper shadow

When to enter

• Can wait for a correction within the hammer's lower shadow (using the hammer's lows as a potential purchasing area)

Other Uses

Hammer can be used as a potential support. We can use the lower shadow of the Hammer to gauge a support line, in the case that the support is solid, the hammer should become the support. However, if support is breached, our bullish outlook would have been voided.

#2 Hanging Man

Important to wait for bearish confirmation with the Hanging Man. Minimally, there should be a lower opening under the real body of the hanging man (but a close beneath the hanging man real body is preferred). Hanging man should be at an all-time-high (or at least a high for a significant move).

A cautionary signal before a Hanging Man could be that bullish candles prior have upper shadows, and there is a decreasing slope of rally highs.

When to enter

• After a confirmation of the hanging man

• Avoid buying at the opening/closing of the hanging man (highs of the move)

#3 Engulfing Patterns

It is the first of multiple candle line patterns and is a major reversal signal with two opposite color real bodies composing this pattern.

#1 Bullish/Bearish Engulfing Pattern

1. Clearly definable uptrend (bearish engulfing pattern) or a clearly definable downtrend (bullish engulfing pattern), even if the trend is short

2. Two candles comprise of the engulfing pattern, where the second real body must engulf the prior real body (need not engulf the shadows)

3. Second real body of the engulfing pattern should be the opposite color of the first real body.

   • Exception is that doji engulfed by a large white body could be a bottom reversal (in downtrend)

   • Doji engulfed by a large black body could be a top reversal (in uptrend)

Factors to improve likelihood of engulfing pattern

1. First day has a very small body and second day has a very long body

Reflects a dissipation of the prior's trend force and the large second real body proves an increase in force behind the new move

2. Appears after a protracted or very fast move

Creates an overextended market (overbought/oversold)

3. Heavy volume on the second real body of engulfing pattern

Rationale behind Dark-Cloud Cover

Bulls are in complete control from the first day large white candle till the second day open. However, the technical picture changes afterwards as the market closes not only beneath the prior close, but well within the prior day's real body - offsetting the gain of the first session. Many who are waiting to sell short will have a benchmark to place the stop - at the new high of the second day cloud pattern- while the longs will have second thoughts on their position.

More factors to consider (in increasing importance)

1. The greater the penetration of the black body's close into the prior white real body, the greater the chance of a top reversal. Think of how if the black candle fully engulfs the white candle's body it is a bearish engulfing pattern. Hence the bearish engulfing pattern can be a stronger reversal than a dark-cloud pattern. A strong white candle after a bearish pattern could signify a reversal into another bullish stance i.e. another rally (3 Candles: 2 forming a bearish pattern, followed by one strong white candle).

2. If the second body of dark-cloud cover opens above a major resistance level and then fails, it shows that the bulls were unable to take control of the market

3. On the second day, very high volume could lead to a buying blowoff (many new buyers jump into buying the stock then the market sells off very quickly).

4. The highest high of the two sessions that formed the dark-cloud cover should be a resistance (Additional Point, not in any order of importance)

Rationale behind a Piercing Pattern

The market is in a downtrend. The bearish black real body reinforces this view. The next session the market opens via a gap, but the market surges forward closing way above the previous day's close. Those who are looking to buy would say no new lows could not hold and could view it as an opportunity to buy.

More factors to consider (in increasing importance)

1. On the second day, very high volume could lead to a selling blowoff (many sellers close their position on the lower opening by selling but the market quickly buys up the stock)

2. If the second body of the piercing pattern opens below a major support level and then fails, it shows that the bears were unable to take control of the market

3. The pattern's white candlestick should push more than halfway into the black candlestick's real body. This is so that it is not confused with other similar patterns (namely On-Neck, In-Neck and Thrusting Pattern) which gives a different reversal signal.

4. The lowest point of the two sessions that formed the piercing pattern can be the support (Additional Point, not in any order of importance)

5. Good to wait for confirmation with a high close the session after the white candle if the piercing pattern doesn't push deeply into the prior black candle