The most commonly used price action indicator is the study of price bars which give details such as the open and closing price of a market and its high and low price levels during a specific time period. The most commonly used price bars which are used as a price action indicator, are called candlesticks.
The Shooting Star Signal is a one candle pattern appearing in an uptrend.
The shadow (or tail) should be at least two times the length of the body.
The color of the body is not important, although a black body has slightly more Bearish indications.
- The real body is at the lower end of the trading range. The color of the body is not important although a black body should have slightly more bearish implications.
- The upper wick should be at least two times the length of the body.
- There should be very little or no lower shadow.
- Further confirmation is required to indicate a reversal signal. The following day needs to confirm the Shooting Star signal with a black candle or even better, a gap down with a lower close.
- The longer the upper shadow, the higher the potential of a reversal occurring.
- A gap up from the previous day’s close sets up for a stronger reversal move provided the day after the Shooting Star signal opens lower.
- Larger volume on the Shooting Star day increases the probability that a sell-off day has occurred and a reversal is possible.
After a strong uptrend, the Bulls appear to still be in control with price opening higher, but by the end of the day, the Bears step in and take the price back down to the lower end of the trading range, creating a small body for the day. The long upper shadow represents that the Bears had started shorting at these levels.
Even though the Bulls may have been able to keep the price positive by the end of the bar, the Bears made a good showing. Lower trading the next day reinforces the probability of a reversal.
A very important signal is the Hammer signal. It is extremely easy to spot since it really does look like a hammer, the body is fairly square, there is little or no wick on top, and the lower shadow is generally at least twice the length of the body.
The Hammer is a single candle. At the bottom of a downtrend, the trade opens near or slightly below the previous day’s trade, drops down during the day to some value, and closes slightly above or below the open.
This is an indication that the buyers are stepping in and maybe the beginning of the reversal. If the close is higher than the open, this is a slightly stronger indication of a reversal than if the close is lower than the open. To be sure, it is wise to wait another day to make sure the trend has really reversed.
- The lower shadow should be at least two times the length of the body.
- The real body is at the top end of the trading range. While a white body is slightly stronger, it is not required to signal the reversal.
- There should be little or no upper wick.
- Watch the next day to ensure the reversal is not a “fake”.
- The longer the lower shadow, the higher probability of a reversal.
- A gap below the previous day’s close indicates a stronger reversal if the following day after the Hammer opens higher.
- Large volume trading on the Hammer day indicates that the reversal is occurring.
The market trend was on its way down. The price opens and starts moving down as investor sentiment is still in sell. The buyers step in and start pushing the price back up, thinking they have hit the low end and its time to buy.
The price moves back up to the top of the trade range, closing either slightly below or slightly above the opening. This shows the sellers could not maintain control and the downtrend is slowing down. The upward rally of the price starts the sellers thinking that the decline is over.
If the next day opens higher, this indicates the sellers have given control back to the buyers, and the reversal is likely to be continued.
The Pattern Indicators
The pattern can be bullish or bearish depending on the preceding trend and the pattern also shows us that the market has expanded in the most recent period. In the case of a bullish outside bar candlestick pattern we would see the market open lower than the previous close and close higher than the previous open.
- Bullish and Bearish Outside Bars (BEOB/BUOB)
- Bullish and Bearish Engulfing Bars (BEEB/BUEB)
Bullish and Bearish Outside Bars ( BEOB/BUOB)
For an outside bar the high and the low have to be higher and lower than the previous high and low but the open and close could be close together.
Bullish and Bearish Engulfing Bars ( BEEB/BUEB)
For an engulfing bar the open and close have to be higher and lower than the previous bars open and close.
KEY REVERSAL BAR
What does it look like?
A key reversal bar is a particular instance of a reversal bar that shows clearer signs of a reversal.
A bullish key reversal bar opens below the low of the previous bar and closes above its high.
A bearish key reversal bar opens above the high of the previous bar and closes below its low.
By definition, key reversal bars open with a price gap. As gaps within intraday time frames are rare, you will find most key reversal bars in the daily and above time-frames.
What does it mean?
A down gap is a powerful down thrust. When the market rejects such a strong bearish move with certainty, it might have reversed its sentiment to bullish.
On the other hand, when a gap upwards bumps into clear resistance, the market might have turned bearish.
Essentially, a key reversal bar is a violent display of strength that hints at a change of market sentiment.
How do we trade it?
- Buy above a bullish key reversal bar (If uncertain, wait for the price to close above it before buying.)
- Sell below a bearish key reversal bar (If unsure, wait for the price to close below it before selling.)