In September we outlined 6 signs of a bearish technical reversal. But the buy-the-dip strategy only works if traders can identify the transition from a bearish trend to a bullish one. Just because a stock is trading lower than it was a week or a month ago, does not necessarily mean it’s a bargain.
Here are five patterns for technical traders to watch for that indicate a bullish reversal.
On a candlestick chart, the bullish hammer is a candle with a long lower shadow and a small body at or near the top of its range. The trading action indicates that the stock traded lower throughout the day but found meaningful buying volume at lower prices, driving the price higher into the close. A textbook bullish hammer has almost no upper shadow and a lower shadow that is at least twice the size of the body of the candle.
A bullish engulfing pattern is formed when a smaller black candle is followed by a large white candle that completely engulfs the smaller candle. In other words, the stock opens at a lower price than the previous day’s close and closes at a higher price than the previous day’s open. The pattern is indicative of a pessimistic lower opening price that is immediately met with heavy buying pressure throughout the day.
The piercing line is similar to the bullish engulfing in every way but one: instead of closing above the preceding black candle, the white candle finishes lower than the previous day’s open. A piercing line pattern can result when a bullish engulfing pattern is forming, but the market session ends before the second day’s closing price rises above the previous day’s opening price.
The bullish morning star pattern is a series of three candles that often signals at least a short-term bottom. The pattern is made up of a black candlestick followed by a short, star-like candle that gaps down from the previous day’s close. The third candle in the pattern is a large white candle that indicates strong buying pressure. The large black candle demonstrates bearish conviction among traders, the short star-like candle shows indecision, and the large white candle demonstrates a decisive turn from bearish to bullish action.
The three white soldiers bullish reversal pattern is one of the simplest to recognize. It is characterized by three consecutive white candles with bodies that are at least average sized and include consecutive higher opening and closing prices. The staircase-like pattern is a textbook example of bullish trading action.
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