Written by Robert McKinley

Candlestick Reversal Patterns

Reversal patterns are just what they sound like. When a currency price is trending upward and then a downward trend develops, there has been a reversal. This reversal, once established, is called a reversal pattern.

1. First, we must identify a prior trend in order to have a trend to reverse. We identify a trend with trend lines, moving averages, and other technical-analysis tools. You can learn more about these things later.
2. After we have identified a trend, we need to identify and establish the fact that a reversal is about to or has occurred.

Here’s where our very useful Japanese candlesticks come in.

Hammer and Hanging Man

Even though they look alike, depending on prior price action, they have completely different meanings. As you will see, they both have small bodies (hollow or filled) with long lower shadows and short (or absent) upper shadows.

So what do they tell us?

The Hammer

• The hammer signifies that a bullish reversal pattern is forming during a downtrend. It is called a “hammer” to express the idea that the market is hammering out a bottom.
• When we watch a downtrend and see a hammer it tells us that the downtrend is approaching its bottom and that the price will reverse and begin an uptrend.
• The long lower shadow tells us that sellers were able to drive prices lower, however, the buyers managed to outdo the sellers and the price closed near its open.

Again, here’s what to look for to identify a hammer:

• The long lower shadow is about two or three times the length of the real body.
• There is little to no upper shadow.
• The real body is located at the upper end of the trading range.
• The real body can be any color – empty or filled.

The Hanging Man

• While the hammer is a bullish reversal pattern, the hanging man is a bearish reversal pattern. The difference is because of the prior trend, which in this case is upward instead of downward for a hammer reversal pattern.
• It can signify a top or a strong resistance level.
• It tells us that when the price is trending upward (as opposed to downward for a hammer reversal pattern) and a hanging man appears, the sellers are beginning to outdo the buyers.
• As with the hammer, the long lower shadow tells us that the sellers have driven prices lower during the session and that the buyers managed to drive the price back up to near the open price.
• This is very important information because it indicates that the buyers have disappeared and there is no one left to maintain the uptrend.

Again, here’s what to look for to identify a hanging man:

• The long lower shadow is about two or three times the length of the real body.
• There is little to no upper shadow.
• The real body is located at the upper end of the trading range.
• The real body can be any color – empty or filled. However, a black body is more bearish than a white body.

The Inverted Hammer and Shooting Star

• They look the same.
• Again, the information they give us is different only because of the prior trend – whether it is an uptrend or a downtrend.

The Inverted Hammer

• If an inverted hammer appears while prices are falling, it can suggest that a reversal is possible.
• The long upper shadow tells us that buyers have attempted to bid the price up. But it also tells us that the sellers caught on to what the buyers were doing and tried to drive the price back down.
• However, the buyers won out and were able to overcome the sellers to close the session near the open.
• This tells us that since the price was not driven lower, most, if not all, of the sellers must have dropped out and that the only traders left are buyers.

The Shooting Star

• It looks the same as the inverted hammer but it appears when prices are rising (as opposed to the inverted hammer that appears when prices are falling).
• It is a bearish reversal pattern.
• By its shape, we can see that the price opened at its low, then rallied and finally went back to the bottom.
• In this case, it tells us that the buyers tried to drive the price up but were outdone by the sellers.
• So, since there are few or no buyers left, it is a bearish indicator.

The next lesson is Review of Japanese Candlesticks