REVERSAL PATTERNS

Hammer and Hanging :

The hammer and hanging man can be recognized by three criteria:

1. The real body is at the upper end of the trading range. The color of
the real body is not important.
2. A long lower shadow should be twice the height of the real body
3. It should have no, or a very short, upper shadow.

Obs: It is especially important that you wait for bearish confirmation. The greater the down gap between the real
body of the hanging-man day and the opening the next day the more likely the hanging man will be a top. Another
bearish verification could be a black real body session with a lower close than the hanging-man sessions close .
A reversal pattern does not mean that prices will
reverse. A reversal indicator implies that the prior trend should end.

Engulfing pattern :

The engulfing pattern is a major reversal signal with two opposite color real bodies
composing this pattern.

There are three criteria for an engulfing pattern:

1. The market has to be in a clearly definable uptrend or downtrend, even if the trend is
short term.
2. Two candlesticks comprise the engulfing pattern. The second real body must engulf the
prior real body (it need not engulf the shadows).
3. The second real body of the engulfing pattern should be the opposite color of the first
real body. (The exception to this rule is if the first real body of the engulfing pattern is so
small it is almost a doji (or is a doji). Thus, after an extended downtrend, a tiny white real
body engulfed by a very large white real body could be a bottom reversal. In an uptrend,
a minute black real body enveloped by a very large black real body could be a bearish
reversal pattern).

Obs: Some factors that would increase the likelihood that an engulfing
pattern would be an important reversal indicator would be:

1. If the first day of the engulfing pattern has a very small real body and
the second day has a very long real body. This would reflect a dissipation
of the prior trend's force and then an increase in force behind
the new move.
2. If the engulfing pattern appears after a protracted or very fast move.
A protracted trend increases the chance that potential buyers are
already long. In this instance, there may be less of a supply of new
longs in order to keep the market moving up. A fast move makes the
market overextended and vulnerable to profit taking.
3. If there is heavy volume on the second real body of the engulfing
pattern. This could be a blow off (volume using candlestick charts is
discussed in Chapter 15).
4. If the second day of the engulfing pattern engulfs more than one real
body.

DARK-CLOUD COVER :

It is a two candlestick pattern that is a top reversal after a uptrend or, at times,
at the top of a congestion band. The first day of this two candlestick pattern
is a strong white real body.The second day's price opens above the prior session's high
(that is, above the top of the upper shadow). However,
by the end of the second day's session, the market closes near the
low of the day and well within the prior day's white body. The greater
the degree of penetration into the white real body the more likely a top
will occur. Some Japanese technicians require more than a 50% penetration
of the black session's close into the white real body. If the black
candlestick does not close below the halfway point of the white candlestick
it may be best to wait for more bearish confirmation following the
dark cloud cover.

The following is a list of some factors that intensify the importance of

dark-cloud covers:

1. The greater the degree of penetration of the black real body's close
into the prior white real body, the greater the chance for a top. If the
black real body covers the prior day's entire white body, a bearish
engulfing pattern would occur. The dark-cloud cover's black real
body only gets partially into the white body. Think of the dark-cloud
cover as a partial solar eclipse blocking out part of the sun (that is,
covers only part of the prior white body). The bearish engulfing pattern
can be viewed as a total solar eclipse blocking out the entire sun
(that is, covers the entire white body). A bearish engulfing pattern,
consequently, is a more meaningful top reversal. If a long, white real
body closes above the highs of the dark-cloud cover, or the bearish
engulfing pattern, it could presage another rally.
2. During a prolonged uptrend, if there is a strong white day which
opens on its low (that is, a shaven bottom) and closes on its high (that
is, a shaven head) and the next day reveals a long black real body
day, opening on its high and closing on its low, then a shaven head
and shaven bottom black day have occurred.
3. If the second body (that is, the black body) of the dark-cloud cover
opens above a major resistance level and then fails, it would prove
the bulls were unable to take control of the market.
4. If, on the opening of the second day there is very heavy volume, a
buying blow off could have occurred. For example, heavy volume at
a new opening high could mean that many new buyers have decided
to jump aboard ship. Then the market sells offs. It probably won't be
too long before this multitude of new longs (and old longs who have
ridden the uptrend) realize that the ship they jumped onto is the
Titanic. For futures traders, very high opening interest can be another
warning.

PIERCING PATTERN :
Just as a dark-cloud cover is a top reversal, its opposite, the
piercing pattern, is a bottom reversal.It is composed of
two candlesticks in a falling market. The first candlestick is a black real
body day and the second is a long, white real body day. This white day
opens sharply lower, under the low of the prior black day. Then prices
push higher, creating a relatively long, white real body that closes above
the mid-point of the prior day's black real body.
The bullish piercing pattern is akin to the bullish engulfing pattern.
In the bullish engulfing pattern the white real body engulfs the previous
black real body. With the bullish piercing pattern, the white real body
only pierces the prior black body. In the piercing pattern, the greater the
degree of penetration into the black real body, the more likely it will be
a bottom reversal. An ideal piercing pattern will have a white real body
that pushes more than halfway into the prior session's black real body.
If the market closes under the lows of the bullish engulfing pattern or
the piercing pattern by way of a long black candlestick, then another
downleg should resume.

In the section on the dark-cloud cover, I mentioned

that although some Japanese traders like to see the black real
body close more that midway in the prior white candlestick, there is
some flexibility to this rule. With the piercing pattern, there is less flexibility.
The piercing pattern's white candlestick should push more than
halfway into the black candlestick's real body. The reason for less latitude
with the bullish piercing pattern than with the bearish dark-cloud
cover pattern is the fact that the Japanese have three other patterns
called the on-neck, the in-neck, and the thrusting pattern (see Exhibits 4.30
to 4.32) that have the same basic formation as the piercing pattern, but
which are viewed as bearish signals since the white real body gets less
than halfway into the black's real body.
Thus these three potentially bearish patterns (Exhibits 4.30 to 4.32)
and the bullish piercing pattern (Exhibit 4.29) all have the same form.
The difference between them is in the degree of penetration by the white
candlestick into the black candlestick's real body. The on-neck pattern's
white candlestick (usually a small one) closes near the low of the previous
session. The in-neck pattern's white candlestick closes slightly into
the prior real body (it should also be a small white candlestick). The
thrusting pattern should be a longer white candlestick that is stronger
than the in-neck pattern but still does not close above the middle of the
prior black real body.
With these patterns, as prices move under the white candlestick's
low, the trader knows that it's time to sell. (Note that the thrusting pattern
in Exhibit 4.32 is bearish in a declining market, but as part of a rising
market, would be considered bullish. The thrusting pattern is also
bullish if it occurs twice within several days of each other.)

STARS
A star is a small real body that gaps away from the large real body preceding
it (see Exhibit 5.1). It is still a star as long as the star's real body
does not overlap the prior real body. The color of the star is not important.
Stars can occur at tops or at bottoms (sometimes a star during a
downtrend is labeled a rain drop). If the star is a doji instead of a small
real body, it is called a doji star (see Exhibit 5.2).
The star, especially the doji star, is a warning that the prior trend
may be ending.
The star is part of four reversal patterns including:
1. the evening star;
2. the morning star;
3. the doji star; and
4. the shooting star.
In any of these star patterns the real body of the star can be white or
black.

THE MORNING STAR:

The morning star (see Exhibit 5.3) is a bottom reversal pattern.

The market is in a downtrend when we see a black real body. At this

time the bears are in command. Then a small real body appears. This
means sellers are losing the capacity to drive the market lower. The next
day, the strong white real body proves that the bulls have taken over.
An ideal morning star would have a gap before and after the middle
line's real body (that is, the star). This second gap is rare, but lack of it
does not seem to vitiate the power of this formation.
THE EVENING STAR:

The evening star is the bearish counterpart of the morning star pattern.
Since the evening star is a top reversal it should be acted on if it arises after an uptrend.
Three lines compose the
evening star (see Exhibit 5.7). The first two lines are a long, white real
body followed by a star. The star is the first hint of a top. The third line
corroborates a top and completes the three-line pattern of the evening
star. The third line is a black real body that moves sharply into the first
periods white real body.

In principle, an evening star should have a gap between the first and
second real bodies and then another gap between the second and third
real bodies.' However, from my experience this second gap is rarely seen
and is not necessary for the success of this pattern. The main concern
should be the extent of the intrusion of the third day's black real body
into the first day's white real body.

Obs: Some factors that would increase the likelihood that an evening or
morning star could be a reversal would include:

1. If there is a gap between the first candlestick's and star's real bodies
and then in the star's and third candlestick's real bodies;
2. If the third candlestick closes deeply into the first candlestick's real
body;
3. If there is light volume on the first candlestick session and heavy volume
on the third candlestick session. This would show a reduction of
the force for the prior trend and an increase in the direction force of
the new trend.

THE MORNING AND EVENING DOJI STARS

When a doji gaps above a real body in a rising market, or gaps under a
real body in a falling market, that doji is called a doji star. Exhibit 5.2
shows doji stars. Doji stars are a potent warning that the prior trend is
apt to change. The session after the doji should confirm the trend reversal.
Accordingly, a doji star in an uptrend followed by a long, black real
body that closed well into the white real body would confirm a top
reversal. Such a pattern is called an evening doji star (see Exhibit 5.13).
The evening doji star is a distinctive form of the regular evening star.
The regular evening star pattern has a small real body as its star (that is,
the second candlestick), but the evening doji star has a doji as its star.
The evening doji star is more important because it contains a doji.

In a downtrend, if there is a black real body, followed by a doji star,

confirmation of a bottom reversal would occur if the next session was a
strong, white candlestick which closed well into the black real body.
That three candlestick pattern is called a morning doji star (see Exhibit
5.14).

If, during a downtrend, a black candlestick gaps under the doji star, the potentially
bullish implications of the doji star is voided. This is why it is important
to wait for confirmation in the next session or two with doji stars.
If there is an upside gap doji star (that is, the shadows do not touch)
followed by a downside gap black candlestick where the shadows also
do not touch, the star is considered a major top reversal signal. This is
called an abandoned baby top (see Exhibit 5.15). This pattern is very rare!

The same is true, only in reverse, for a bottom. Specifically, if there

is a doji star that has a gap before and after it (where the shadows do not
touch) it should be a major bottom. This pattern is referred to as an
abandoned baby bottom (see Exhibit 5.16). It is also extremely rare!
THE SHOOTING STAR AND THE INVERTED HAMMER

A shooting star is a two-line pattern that sends a warning of an impending

top. It looks like its name, a shooting star. It is usually not a major
reversal signal as is the evening star. As shown in the Exhibit 5.23, the
shooting star has a small real body at the lower end of its range with a
long upper shadow. As with all stars, the color of the real body is not
important.An ideal shooting star has a real body which gaps away from the
prior real body. Nonetheless this gap is not always necessary.

A shooting star shaped candlestick after a downturn could be a bullish

signal. Such a line is called an inverted hammer.

A small real body (that is, a spinning top) reflects indecision.

In the middle of a trading range indecision should be expected.
Exhibit 5.31 illustrates
that an inverted hammer looks like a shooting star line with its long
upper shadow and small real body at the lower end of the range. But,
while the shooting star is a top reversal line, the inverted hammer is a
bottom reversal line. As with a regular hammer, the inverted hammer is
a bullish pattern after a downtrend.
It is important to wait for bullish verification on the session following
the inverted hammer. Verification could be in the form of the next day
opening above the inverted hammer's real body. The larger the gap the
stronger the confirmation. A white candlestick with higher prices can
also be another form of confirmation.
The reason bullish verification of the inverted hammer is important is
because the price action that forms the inverted hammer appears bearish.

The longer the market holds above the inverted hammer's real body the more likely
these shorts will cover.

THE HARAMI PATTERN

The harami pattern (see Exhibit 6.1) is a small real body which is contained
within a prior relatively long real body.
The harami pattern is the reverse of the engulfing pattern. In the
engulfing pattern, a lengthy real body engulfs the preceding small real
body. For the harami, a small real body follows an unusually long real
body. For the two candlesticks of the engulfing pattern the color of the
real bodies should be opposite to one another. This is not necessary-for
the harami.
The harami pattern is usually not as much of a significant reversal
signal as are, say, the hammer, hanging man, or engulfing patterns.
With the harami a brake has been applied to the market; the immediate
preceding trend should end and the market will often come to a lull. At
times, the harami can warn of a significant trend change-especially at
market tops.
The harami pattern is usually not as much of a significant reversal
signal as are, say, the hammer, hanging man, or engulfing patterns.
With the harami a brake has been applied to the market; the immediate
preceding trend should end and the market will often come to a lull. At
times, the harami can warn of a significant trend change-especially at
market tops.
Exhibit 6.3 illustrates a distinctive type of harami called a harami cross.
A harami cross has a doji for the second day of the harami pattern
instead of a small real body. The harami cross, because it contains a
potent doji is viewed as a major reversal signal. The harami cross is sometimes
referred to as the petrifying pattern.
Harami Cross

The regular harami has a tall real body followed by a smaller real body.
Yet, there are no rules as to what is considered a "small" candlestick.
This, like many other charting techniques, is subjective. As a general
principle, the smaller the second real body, the more potent the pattern.
This is usually true because the smaller the real body, the greater the
ambivalence and the more likely a trend reversal.

As mentioned, a doji preceded by a long real body is called a harami

cross. The harami cross carries more significance than a regular harami
pattern. Where the harami is not a major reversal pattern, the harami
cross is a major reversal pattern.

TWEEZERS TOPS AND BOTTOMS:

Tweezers are two or more candlestick lines with matching highs or lows.
In a rising market, a tweezers top is formed when the highs
match. In a falling market, a tweezers bottom is made when the lows are
the same. The tweezers could be composed of real bodies, shadows,
and/or doji. A tweezers occurs on nearby or consecutive sessions and as
such are usually not a vital reversal signal. They take on extra importance
when they occur after an extended move or contain other bearish
(for a top reversal) or a bullish (for a bottom reversal) candlestick signals.
Exhibits 6.13 through 6.18 elaborate on this idea.
BELT-HOLD LINES
The belt hold is an individual candlestick line which can be either bullish
or bearish. The bullish belt hold is a strong white candlestick which
opens on the low of the day (or with a very small lower shadow) and
moves higher for the rest of the day. The bullish belt-hold line is also
called a white opening shaven bottom. If, as in Exhibit 6.25, the market is at
a low price area and a long bullish belt hold appears, it forecasts a rally.
The bearish belt hold (see Exhibit 6.26) is a long black candlestick which
opens on the high of the session (or within a few ticks of the high) and
continues lower through the session. If prices are high, the appearance
of a bearish belt hold is a top reversal. The bearish belt-hold line is
sometimes called a black opening shaven head.
The longer the height of the belt-hold candlestick line, the more significant
it becomes. Belt-hold lines are also more important if they have
not appeared for a while.

UPSIDE-GAP TWO CROWS

An upside-gap two crows (what a mouthful) is illustrated in Exhibit 6.30.

The upside gap refers to the gap between the real body of the small black
real body and the real body preceding it (the real body which precedes
the first black candlestick is usually a long white one). The two black
candlesticks are the "crows" in this pattern. They are analogous to black
crows peering ominously down from a tree branch. Based on this portentous
comparison, it is obviously a bearish pattern. An ideal upsidegap
two crows has the second black real body opening above the first
black real body's open. It then closes under the first black candlestick's
close.

There is a related pattern that looks something like an upside-gap

two crows. Unlike the upside-gap two crows, it is a bullish in a rising
market. As such, it is one of the few candlestick continuation patterns.
(Other continuation patterns are discussed in Chapter 7.) It is called a
mat-hold pattern (see Exhibit 6.31). This pattern occurs in a bull market
and is a bullish continuation pattern. The first three candlesticks are
similar to the upside-gap two crows but another black candlestick follows.
If the next candlestick is white and gaps above the last black candlestick's
upper shadow or closes above the last black candlestick's high,
then buying is warranted. This pattern can have two, three, or four black
candlesticks. The upside gap two crows and the mat-hold are relatively
rare.
THREE BLACK CROWS

The upside-gap two crows consists of two black candlesticks. If there are
three declining consecutive black candlesticks it is called three black crows
pattern (see Exhibit 6.35).
The three black crows presage lower prices if
they appear at high-price levels or after a mature advance.The three crows are,
as the name implies, three black candlesticks. Likened to the image of a group of crows
sitting
ominously in a tall dead tree, the three crows have bearish implications.
The three lines should close at, or near, their lows. Each of the openings
should also be within the prior session's real body. The analyst would
also like to see the real body of the first candlestick of the three crows
under the prior white session's high.

COUNTERATTACK LINES
Counterattack lines are formed when opposite colored candlesticks have
the same close. The best way to describe this pattern is by discussing the
illustrations in Exhibits 6.38 and 6.39. Exhibit 6.38 is an example of a
bullish counterattack line. This pattern occurs during a decline. The first
candlestick of this pattern is long and black. The next session opens
sharply lower. At this point, the bears are feeling confident. The bulls
then stage their counterattack as they push prices back up to unchanged
from the prior close. The prior downtrend has then been bridled.
The bullish counterattack is comparable to the bullish piercing line. If
you remember, the piercing line has the same two-candlestick configuration
as that shown for the bullish counterattack pattern. The main difference
is that the bullish counterattack line does not usually move into
the prior session's white real body. It just gets back to the prior session's
close. The piercing pattern's second line pushes well into the black real
body. Consequently, the piercing pattern is a more significant bottom
reversal than is this bullish counterattack line. Nonetheless, as shown in
some examples below, the bullish counterattack line should be
respected.
Obs: An important consideration of these counterattack lines is if the second
session should open robustly higher (in the case of the bearish
counterattack) or sharply lower (for the bullish counterattack). The idea
is that on the opening of the second day of this pattern, the market has
moved strongly in the direction of the original trend. Then, surprise! By
the close, it moves back to unchanged from the prior 'session!

CONTINUATION
PATTERNS
Upward- and Downward-Gap Tasuki

The upside-gap tasuki (see Exhibit 7.14) is another continuation pattern.

The market is in an uptrend. A white candlestick gaps higher and is followed
by a black candlestick. The black candlestick opens within the
white real body and closes under the white candlestick's real body. The
close on the black candlestick day is the buy point. If the market fills in
the gap (closes the window) and selling pressure is still evident, the
bullish outlook of the upside-gap tasuki is voided. The same concepts
would be true, in reverse, for a downward-gap tasuki (see Exhibit 7.15).
The real bodies of the two candlesticks in the tasuki gap be should be
about the same size. Both types of tasuki gaps are rare.

High-price and Low-price Gapping Plays

It is normal after a sharp one to two session advance for the market to
consolidate the gains. Sometimes this consolidation is by a series of small
real bodies. A group of small real bodies after a strong session tells us
that the market is undecided. However, if there is an upside gap on the
opening (that is, a window) from these small real bodies, it is time to
buy. This is high-price gapping play pattern (see Exhibit 7.17). It is called
this because prices hover near their recent highs and then gaps to the
upside.
A low-price gapping play is, not surprisingly, the bearish counterpart of
the high-price gapping play. The low-price gapping play (see Exhibit
7.18) is a downside window from a low-price congestion band. This
congestion band (a series of small real bodies) initially stabilized a steep
one to two session decline. At first, this group of small candlesticks gives
the appearance that a base is forming. The break to the downside via a
window dashes these bullish hopes.
RISING AND FALLING THREE METHODS

These three methods include the bullish rising three methods and the bearish
falling three methods. (Note how the number three again makes an
appearance.) These are both continuation patterns. The benchmarks for
the rising three methods pattern (see Exhibit 7.25) include:

1. A long white candlestick.

2. This white candlestick is followed by a group of falling small real
body candlesticks. The ideal number of small candlesticks is three but
two or more than three are also acceptable as long as they basically
hold within the long white candlestick's range. Think of the small
candlesticks as forming a pattern similar to a three-day harami pattern
since they hold within the first session's range. (For this pattern that
would include holding within the shadows; for a true harami it would
only include the real body.) The small candlesticks can be any color,
but black is most common.
3. The final day should be a strong white real body session with a close
above the first day's close. The final candlestick line should also open
above the close of the previous session.
The falling three methods pattern (see Exhibit 7.26) is the bearish
counterpart of the rising three methods pattern. For this pattern to
occur, the market should be in a downtrend and a long black candlestick
should emerge. It is followed by about three small rising candles (usually
white) whose real bodies hold within the first candlestick's range
(including shadows). The final session should open under the prior close
and then close under the first black candlestick's close.After this last
black candlestick session, the market should head lower. This pattern
resembles a bear flag or pennant formation.

THREE ADVANCING WHITE SOLDIERS

Like much of the candlestick terminology, this pattern has a military

association. It is known as the three advancing white soldiers (see Exhibit
7.36) or, more commonly, three white soldiers. It is a group of three white
candlesticks with consecutively higher closes. If this pattern appears at a
low price area after a period of stable prices, then it is a sign of strength
ahead.
The three white soldiers are a gradual and steady rise with each
white line opening within or near the prior session's white real body.
Each of the white candlesticks should close at, or near, its highs.

If the second and third, or just the third candlestick, show signs of
weakening it is an advance block pattern (see Exhibit 7.37). This means that
the rally is running into trouble and that longs should protect themselves.
Be especially cautious about this pattern during a mature
uptrend. Signs of weakening could be progressively smaller white real
bodies or relatively long upper shadows on the latter two white candlesticks.
Although the advance block and stalled patterns are not normally top
reversal patterns, they can sometimes precede a meaningful price
decline. The advance block and stalled patterns should be used to liquidate
or protect longs (for example, sell covered calls) but not to short.
They are generally more consequential at higher price levels.

If the last two candlesticks are long white ones that make a new high
followed by a small white candlestick, it is called a stalled pattern (see
Exhibit 7.38). It is also sometimes called a deliberation pattern. After this
formation the bull's strength has been at least temporarily exhausted.
This last small white candlestick can either gap away from the long white
body (in which case it becomes a star) or it can be, as the Japanese
express it, "riding on the shoulder" of the long white real body (that is,
be at the upper end of the prior long white real body). The small real
body discloses a deterioration of the bulls' power. The time of the stalled
pattern is the time for the longs to take profits.

SEPARATING LINES

Whereas the counterattack

line has the same close, the separating lines in Exhibit 7.42 have the
same open as the previous opposite color candlestick. The separating line
is a continuation pattern.
During a market rise, a black real body (especially a relatively long
one) would be cause for concern if you are long. The bears might be
gaining control. However, if the next session's opening gaps higher to
open at the previous black session's opening price, it shows that the
bears lost control of the market. If this white candlestick session then
closes higher, it tells us the bulls have regained control and the prior
price rise should continue.

This is the scenario which unfolds with the bullish separating line as shown in Exhibit
7.42. The white line should
also be a bullish belt hold (that is, open on the low of the session). The
opposite would be true with the bearish separating line in exhibit 7.42.
This is viewed as a bearish continuation pattern.