Do you know that the shape of just one single candlestick can help you to easily assess the market sentiment?
In this article, we'll explore the power of candlestick patterns in identifying trend reversals.
We will cover strong, medium and weak candlestick reversal signals, and I will show you a pattern with an impressive 75% accuracy rate.
Before we start, please, remember that candlestick patterns alone give very poor signals. We will discuss the candlesticks that are formed on a potentially significant points of interest, such as:
fibonacci levels,
support and resistance,
trend lines,
liquidity zones.
And now, some important theory:
Remember that we assess the shape of a candlestick in a relation to previous candlesticks.
We will call a candlestick weak, if its range is smaller than the range of the average candles.
While a strong candlestick will be a candle that has a range, bigger than the range of the average candles.
Here are the three most common reversal formations that you may encounter trading different markets:
1️⃣ - Inside bar formation
Once the price reaches some important pivot point quite often it tends to form a weak candle with a long rejection wick (long in comparison to the buddy of the candle).
In case if the consequent candle's body has the same range, we call that the equal inside bar.
It can be treated as the reversal formation ONLY with additional confirmation.
Without an additional trigger, chances will be high that the market will start a sideways movement instead.
Here is a key horizontal structure support that EURUSD is testing on a daily.
After a test of structure, the price formed 2 small, low momentum bullish and bearish candles.
According to the rules, we can also call these candles - doji.
These candles don't leave bullish or bearish clues, they signify a weakness and don't give a reliable signal.
After a consolidation, the pair simply started to drop lower.
2️⃣ - Engulfing candle
Once the price reaches some important pivot point quite often it tends to form a weak candle with a long rejection wick (long in comparison to the buddy of the candle).
In case if the consequent candle's body engulfs (has a bigger range) the previous candle, we call that the engulfing candle.
By itself, it is a quite strong reversal signal and can be applied as a trigger for opening a trading position.
Look how the price reacted to a key daily horizontal support.
After its test, the price formed a bullish engulfing candle that completed engulfed a previous bearish candle.
That was a perfect bullish confirmation, and the pair started to grow rapidly then.
3️⃣ - Engulfing candle (2X)
Sometimes, the engulfing candle engulfs not only the previous candle but also one more preceding one.
We also can call such a candle a high momentum candle.
It is considered to be the strongest reversal formation (among these 3) and can be applied as a signal for a trade entry.
Have a look at a test of a key horizontal daily resistance on USDJPY.
The price formed a high momentum bearish candle, engulfing the range of previous 2 bullish candles.
That was a strong bearish signal, and the pair dropped sharply then.
❗️Remember that candlestick patterns work only on strong pivots /structure levels. Being formed on random levels, the performance of these formations is relatively low.
