Top Trend Reversal Patterns Every Trader Must Know

Being able to identify trend reversal patterns is crucial for successful trading and investing. These patterns can be extremely beneficial for traders and investors since they signal the end of an existing trend and the potential start of a new one, which can result in significant profits. Moreover, recognizing trend reversal patterns can also enhance decision-making and improve overall performance in the markets.

This article will provide a comprehensive overview of the most prominent trend reversal patterns (especially the candlestick bullish reversal patterns), including the bullish engulfing pattern, piercing pattern, bullish harami, hammer, morning star, and lots more. By reading this article, readers will develop a solid understanding of how to identify these patterns effectively.

What are Trend Reversal Patterns?

Trend reversal patterns are technical analysis tools used to identify a potential reversal in the price trend of an asset. These patterns appear on a chart when an existing trend is expected to change direction, indicating a shift in market sentiment.

Traders and investors use these patterns to find possible trading opportunities and to control risk by putting in stop-loss orders to limit possible losses.

Bullish Confirmation

The formation of patterns can occur with one or multiple candlesticks, and usually necessitates bullish confirmation. A confirmed reversal indicates that buyers were successful in overcoming the selling pressure of sellers. However, it remains uncertain whether new buyers will enter the market and make prices move up.

Without confirmation, these patterns would be considered neutral, indicating at best a potential level of support. Bullish confirmation indicates that there will be more upside movement, which can appear as a long green candlestick, a gap up, or a high-volume advance.

Candlestick patterns only work for one to two weeks, so bullish confirmation should happen within one to three days after the pattern.

Existing Downtrend

There must be an existing downtrend to reverse for a bullish reversal to occur. A pattern called a "bullish engulfing" that occurs when an asset’s price reaches new highs does not necessarily signal a bullish reversal. Instead, it suggests that buyers are continuing to drive up the price, and the pattern could indicate a continuation of the trend.

Peak/ trough analysis, moving averages, and trend lines can be used to determine the existence of a downtrend.

Additional Technical Analysis

Candlesticks are an excellent tool for identifying short-term reversals, but they should not be used in isolation. To make the reversal more solid, other parts of technical analysis can and should be added.

Here are three ideas for combining traditional technical analysis with candlestick analysis:

Support

To make the analysis more robust, look for bullish reversals at support levels. Trend lines, moving averages, Fibonacci retracements, and previous reaction lows, can be used to identify support levels.

Momentum

Oscillators can be used to confirm rising momentum with bullish reversals. Positive divergences in RSI, MACD, PPO, StochRSI, Williams%R, or Stochastics would indicate improved momentum and strengthen the confirmation of a bullish reversal pattern.

Money Flows

Money Flows access buying and selling pressure through volume-based indicators. Candlesticks can be used in conjunction with On Balance Volume (OBV), Chaikin Money Flow (CMF), and the Accumulation/Distribution Line. Strength in any of these would increase the reversal's robustness.

You can take the analysis a step further by combining all three aspects. Look for positive divergences, a bullish candlestick reversal, and signs of buying pressure in assets that are trading near support.

Candlestick Bullish Reversal Patterns

Candlestick bullish reversals suggest that a downtrend may be about to reverse. These patterns are created by a collection of candlesticks, and they signal a shift in market sentiment, showing that buyers are becoming more powerful than sellers.

Traders and analysts use these patterns to find new chances to buy or to confirm existing bullish signals. The patterns include: 

Bullish Engulfing

This pattern is formed by two consecutive candlesticks. The first candlestick is a small red one, and the second one is a large green one. The body of the green candlestick completely engulfs the body of the red candlestick. Bullish engulfing pattern suggests that the buyers have taken control of the market, and the price is likely to move upwards.

To "engulf" something means to sweep over it, surround it, or completely cover it. One candlestick covers (or engulfs) another in the bullish engulfing pattern.

This two-candlestick pattern appears after a downtrend and is made up of one bearish (covered) candlestick and one bullish candlestick (which does the covering).

Here are the criteria you can use to identify a Bullish Engulfing pattern:

• There must be a clear downward trend.
• There must be a small red candle at the bottom of the downtrend.
• A green candle must follow the red candle, and its body must completely engulf the red candle.
• The green candle's top must be higher than the red candle's top, and its bottom must be lower than the red candle's bottom.

Consider the following when analyzing a specific bullish engulfing pattern:

• The reversal pattern is most likely to be effective if the downtrend that came before it was long and strong.
• The taller the green candle's body, the stronger the candlestick pattern.

Piercing Pattern

As shown in the chart below, a piercing pattern is formed when a bullish candle on Day 2 closes above the middle of a bearish candle on Day 1.

In addition, on Day 2, the price drops significantly but then recovers, filling the price gap that was created. Ultimately, the closing price on Day 2 ends up being very close to the closing price of the bearish candlestick on Day 1 that resulted in losses.

The bulls' rejection of the gap down is usually interpreted as a bullish sign. The fact that bulls were able to press further into the previous day's losses adds to the bullish sentiment. The bulls were able to keep prices higher by absorbing excess supply and increasing demand.

The diagram below illustrates an example of the piercing pattern:

Bullish Harami

This is a candlestick chart indicator that indicates the end of a bearish trend. Some investors may interpret a bullish harami as a signal to enter a long position on an asset.

Here are some strategies for identifying a bullish harami pattern:

• Recognize an existing downtrend.
• Watch for signs that momentum is slowing or reversing (you can use bullish moving average crossovers, stochastic oscillators, or subsequent bullish candle formations for this purpose).
• Check that the body of the small green candle does not exceed 25% of the previous bearish candle. Assets will gap up, with the green candle appearing halfway up the previous candle. The two candles will typically be shown side by side on the charts.
• Look at how the whole bullish candle fits inside the bearish candle that came before it.
• Use supporting indicators or key levels of support to look for confluence.

Traders can use the five-step checklist above to identify bullish harami. We can see the following from the chart below:

• We have a clear downtrend.
• A bullish hammer appears before the bullish harami, indicating that the market is about to reverse.
• The bullish candle is no more than 25% longer than the previous candle.
• The bullish candle opens and closes within the same time frame as the previous candle.
• The RSI indicates whether or not the market is oversold. This could indicate that downward momentum has peaked, but traders should wait for the RSI to return above the 30-line for confirmation.

Stops can be placed below the new low, and traders can enter at the opening of the candle following the bullish harami pattern's completion. Since the bullish harami appears at the beginning of a potential uptrend, traders can include multiple target levels to ride out a new extended uptrend. These objectives can be set at recent levels of support and resistance.

Hammer

This bullish reversal pattern consists of a single candle and usually appears at the end of a downtrend. Its occurrence indicates a potential change in market direction from bearish to bullish. The opening, close, and top prices are all roughly the same, while there exists a long wick that stretches downwards and is twice the size of the short body.

Both examples in the image above are hammers, regardless of the color of the body. Still, the left candle is thought to be stronger because the close is at the top of the candle. This shows that the momentum is strong.

While the hammer candlestick pattern is useful for identifying possible changes in trends, it should not be considered as a standalone signal to buy or sell in trading. Like other trading strategies, hammer candles work best when used with other analysis tools and technical indicators.

The Morning Star

This candlestick pattern signals a bullish trend reversal. It consists of three candles and typically occurs at the end of a downtrend. The pattern shows that the downtrend is slowing down before a big bullish move, which sets the stage for a new uptrend.

When the market is in a bearish trend, most traders believe it will continue to fall. Since they are expecting the market to go down, they are either selling short or getting out of the market.

This sentiment holds when the first candle of the morning star forms. When the second candle forms, the market appears to be having another bearish day because the candle gaps down.

Since the market has fallen significantly, some traders may begin to believe that it will reverse. They begin to believe that a reversal is imminent because the trend has been downward for some time.

As a result, buying pressure rises, making it more difficult for bears to continue driving down prices. The market closes near where it began, forming a Doji candlestick pattern.

The big green candle confirms that the bulls have gained price control. The market has a gap, and more people expect the trend to reverse. The third candle is a bullish candlestick as a result of this sentiment.

Bullish Abandoned Baby

The bullish abandoned baby pattern appears at the end of a downtrend and indicates a trend reversal to an uptrend. It means that selling pressure from bears has stopped and that bulls are coming back to the market.

This pattern is made up of three candlesticks: the first with a large black (or red) body, the second with a small and bearish candle (or a Doji), and the third with a white (or green) body.

The Doji's shadows should be completely gapped below the shadows of the first and third candles. A Doji candlestick has the same opening price and closing price, which shows that both buyers and sellers aren't sure what to do.

The following are the conditions that must be met for the pattern to form:

• The first candle must be negative and part of a downtrend.
• The second candle must be a doji that falls below the previous bar.
• The final candle must gap up and close with a tall bullish candle.
• The bodies and wicks of the three candles must not overlap.

Here's a closer look at a chart illustrating a bullish abandoned baby pattern:

The first candlestick is long and bearish, whereas the second has a very short body or a Doji, and gaps so small that its high price is lower than the first candlestick's low price.

The third candle is long and bullish, with such a large gap that its low price is higher than the high price of the second.

Later, a Doji appears, which shows that the market is leveling off because the prices at the start and end of the day are the same.

The Doji indicates that bears are gradually losing control of the market and that bulls are attempting to seize control. In the uptrend, the third candle forms and gaps higher from the Doji.

After the bullish abandoned baby pattern formed, traders expect the price to go up even more, and the bulls are back in action.

Triple Bottom Pattern

The triple top/bottom pattern is used in the financial markets to help spot future price reversals in assets. It has three valleys that roughly correspond to the same price level, forming a horizontal level of support.

In a triple bottom pattern, the price of the asset reaches a support level three times but is unable to break through it, which causes the price trend to reverse. The pattern is completed when the price crosses over the resistance level, thereby indicating the possibility of an upswing.

The Triple Bottom pattern is often used with other technical analysis tools, such as moving averages and momentum indicators, to confirm a possible change in the way prices move. Traders can use this pattern to direct their trading decisions, such as when to change their risk-management strategies or whether to enter or abandon a trade.

Conclusion

Recognizing trend reversal patterns is vital for traders and investors as it provides them with significant insights into the direction of the market. Professional traders can enhance their success rates by acquiring the knowledge to identify and analyze these patterns, and using this information to determine when to enter or exit positions.

In addition to the trend reversal patterns mentioned in this article, there are other uncommon patterns as well. However, the ones discussed here are some of the most well-known and dependable. It is essential to keep in mind that no pattern can guarantee a specific market outcome, but the ability to recognize and comprehend these patterns can certainly assist traders in making better decisions.