Throughout the week we’ve looked a couple of great price action patterns, the High & Tight Bull Flag and the Fibonacci Retracement.
The High & Tight Bull Flag is a highly effective breakout pattern (Click here to read it now!).
And the Fibonacci Retracement is a precise tool for jumping on pullbacks (Click here to read it now!).
Our first two patterns are some of my favorite. Accurate and predictable with clear guidelines…
But it is the Bullish Reversal that offers the BIGGEST reward potential by looking to buy low and let it ride. It tends to have a lower win rate (like most reversal strats) but the potential can be huge once you perfect your entry.
The Bullish Reversal Pattern
Prepare to fall in love with the Bullish Reversal.
The Bullish Reversal is a candlestick pattern designed to identify market reversals. After a steady down trend, this formation can alert traders to a bullish shift in market sentiment.
A proper setup consists of two things.
The first is a long hammer candle at the end of a downtrend. It should look similar to this:
The candle will open and close around the same price but have a long tail at the bottom.
The reason this is important is that it’s a sign of exhaustion. It signals that the downtrend is likely over. Bears sold heavily but ran out of steam, and the buyers have stepped in to rally the stock back near the opening price.
The sellers are now losing and covering their shorts. For one reason or another, traders are now buying.
It could have been a pre-determined buy level, positive news for the company, a change in the company or commodity’s outlook…
The reason doesn’t matter. The important thing is that the sentiment has now changed.
This is the start of the Bullish Reversal pattern.
The next thing we want to see is significant buying candle following the hammer. Heavy buying will confirm what we saw with the hammer candle.
Again, it all goes back to market sentiment.
The hammer candle told us that the bears were exhausted. They ran out of steam and couldn’t push the stock any lower. Then bulls took over and rallied the stock back up near its open.
If a reversal is underway, I should see a continuation of this new direction. Buyers should maintain control and push the stock or commodity higher.
That’s why I want to see the significant buying candle – to confirm my hypothesis and complete the BULLISH REVERSAL pattern.
Examples of the Bullish Reversal in the Market
This is a daily chart of silver futures. After a 2-month down trend, the market signaled exhaustion with a hammer candle at the low.
Following the exhaustion hammer, the Bullish Reversal was confirmed by significant follow through buying.
The ensuing Bullish Reversal led to a rise of $8.00 an ounce over the next eight weeks.
One of the most lucrative commodity trades of 2016 was orange juice, although it went largely unnoticed. And it all started with a Bullish Reversal.
After a strong year-end selloff, orange juice futures showed their hand with a monster hammer candle making a new low.
This one was hard to miss, and the seller exhaustion couldn’t have been clearer.
The bears ran out of steam, and the chart shifted to a steady stream of higher highs and higher lows. This is exactly what I like to see – positive price action with highs above the top of the hammer candle.
At $7.50 per tick, one futures contract could have delivered a $1,650,000 payday on this one.
The Bullish Reversal pattern can be used on any time frame, making it a favorite for big picture position trading.
Take a look at crude oil after its meteoric collapse in 2008. This is a monthly chart.
Most investors were scared to get long. When a market is in free fall, buying can be like trying to catch a falling knife. But the Bullish Reversal pattern clearly signaled the end of the slide, allowing technicians to buy near the bottom.
As I mentioned earlier, this setup carries limited risk. Stop placement should be just below the low of the hammer candle.
If the reversal is true, prices should not breach the exhaustion low.
The biggest mistake I see traders make is attempting to master dozens of patterns simultaneously. The best in the business stick to a select few and use them to generate consistent profits.
These three setups, the High & Tight Bull Flag, the Fibonacci Retracement, and the Bullish Reversal, are the pinnacle of price action analysis.
But don’t take my word for it. Test them out for yourself. Record what works, what doesn’t, and where you make mistakes.
Once you’re comfortable with a pattern and your P&L backs up its effectiveness – keep pulling the trigger until the profits pile up.
For more price action trading setups check out my Top 3 price action trading strategies.
I really hope you enjoyed this series and look forward to hearing your thoughts!