An understanding of reversals candles can help to manage existing trades or an entry on a new trade.
A single candlestick can be a reversal signal, but a grouping of them can be even more powerful and show the struggle with price and moving higher or lower. The upper and lower shadows become the point of interest, when we see many lined up together it shows us the price struggle.
A tug of war presents itself in the form of long shadows (wicks) on candles and a smaller body shows an even more powerful struggle.
Candlesticks are made up of an opening price, closing price, the high of the time frame and the low of the time frame.
The opening and closing price form the body of the candlestick, while the highs and lows form the shadows on the candlesticks. Shadows are often referred to as wicks or tails on the body. But no matter what you call them they are showing the extended range outside of the opening and closing price of the time frame and how the bears or bulls pulled the price back in after the extension.
Shadows – A bearish signal a long upper shadow and bullish a long lower shadow, but as with all candlestick patterns, where it appears is important.
The Hammer – A reversal indicator after a significant downturn (long lower shadow is bullish).
Hanging Man – A reversal indicator after an uptrend (long lower shadow is NOT bullish).
Shooting Star – A reversal indicator after an uptrend (long upper shadow is bearish).
A little information to help identify and clarify the difference between the hammer, hanging man, and the shooting star:
- Shooting Star—Must appear after an uptrend. The shooting star’s long upper shadow reflects market rejection of higher prices.
- Hammer—A long lower shadow candle that must appear during a downtrend.
- Hanging Man—A long lower shadow candle that must appear during an uptrend.
When price tries to move higher or lower and continues to leave the long shadows, it’s a big red flag for a trader. NOT necessarily a time to reverse your position, but definitely time to tighten stops and pay attention to the upcoming move. Always look at the preceding trend to determine if the hammer, shooting star, or hanging man candles should be acted upon.
Remember that as a possible reversal signals; the existing trend needs to be in place for anything to reverse. Confirmation of the reversal will appear from the candles that follow in an uptrend that is a candle closing lower and in a downtrend it is a candle closing higher that follows the reversal candle.
There are other patterns for reversals, but purely off a single candle the next candle will either confirm or negate the setup. Using other signals off your favorite oscillators or any other indicator can also help to identify the reversal.
More sophisticated indicators and patterns come once the basics are established on identifying key candlestick forming and intermediate or bigger trends. Once that can be done adding onto the candlestick vocabulary become very easy and helps to refine trade management and trade entries. Identifying risk is key to success and once the pattern is in place the candlestick helps to lay that risk out in simple terms.
The reversal confirms and moves the other direction or it does not at that point. Determining if the trade is right or wrong comes in the next few candles, which can be minutes if the trade is done on a short term basis or days if on a daily chart.
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