Skilled technical analysts find chart patterns helpful in determining the direction in which prices will move. Particular candlestick patterns appearing at specific points can alert the trader that the price of the asset they’re looking at will either rise or fall. In this article, you will learn about reversal chart patterns, which indicate a market trend reversal, either from bullish to bearish or vice versa. Continuation chart patterns and bilateral chart patterns are covered in other articles.
The ability to identify and successfully trade these patterns is very useful, as it provides you with great entry (buy) and exit (sell) points, just before the market is about to reverse. The rules are the same for all chart patterns – the pattern has to be fully completed and confirmed with the reversal price action. Trading based on it prior to confirmation can be risky and should be backed by other trading tools, as the pattern itself can be invalidated.
If you find all this talk of patterns confusing, you might first want to read the introductory article to chart patterns to learn the basics about chart patterns, before continuing with this article.
REVERSAL CHART PATTERNS ESSENTIALS
- Reversal chart patterns signify a market trend reversal – from bullish to bearish or vice versa.
- The shapes of reversal chart patterns include:
- Double bottom and double top,
- Head and shoulders and inverted head and shoulders,
- Adam and Eve double bottom and Adam and Eve double top.
- Successfully identifying reversal chart patterns can provide you with great entry and exit points.
The double bottom and double top
Double bottom is one of the strongest reversal pattern formations. Its shape looks like the letter W and is formed when the price rebounds from the same support level two consecutive times. When the price fails to break the same level for the second time, traders can assume that the strength of the support below is sufficient, therefore the market trend can reverse from bearish to bullish. In some cases a double bottom can continue into a triple bottom.
Double top pattern formation signifies a potential conversion of a bull trend into a bear trend. As opposed to the double bottom pattern, the price here fails to break a certain resistance level twice in a row. The shape it paints on a chart looks like a letter M. Sometimes a double top pattern can also turn into a triple top pattern, followed by the same result when confirmed – a trend reversal and a decline in price.
The head and shoulders
The head and shoulders is a bearish pattern which consists of three peaks. The two lower peaks at the sides are called the shoulders, while the higher middle peak is called the head. The bottoms on either side of the head represent the neckline, which is a significant price level for this pattern.
The pattern starts with a price surge, followed by a price decline, forming the first top – the left shoulder. After the decline, the price picks up and rallies above the first shoulder, establishing a higher high and thus forming the head of the pattern. After this high, there is some downward price reaction. As the price rebounds at the same support level as before, it provides us with the neckline level. At the end of the pattern, the right shoulder is formed, with its peak at approximately the same level as the left shoulder.
The pattern is confirmed if the price falls below the neckline level after the right shoulder is formed. When this happens, traders can assume that the price will decline further.
Inverse head and shoulders is an upside-down mirror image of the head and shoulders pattern. As opposed to the head and shoulders pattern, this one indicates the end of a bearish trend and the start of a bullish one.
It consists of three lows: the first one is called the left shoulder, the middle (lowest one) is called the head, and the last one is called the right shoulder. The pattern also features the neckline. This is the level where the price was rejected from climbing higher after the left shoulder and head were formed. The right shoulder completes the pattern.
If the neckline level is broken through after the right shoulder is formed, the pattern is considered completed – traders can assume that the price will begin to rise.
The Adam and Eve
Adam and Eve double bottom pattern is considered one of the strongest trend reversal bullish patterns. It consists of two bottoms, but they are rather different than in the previously described double bottom pattern.
The pattern starts with a steep decline in price accompanied by high trading volume. This way, the first bottom appears, where the price bounces hard and fast, forming a “V” shape. This bottom is called Adam. After the price rebound and some upward movement, the price eventually starts declining again, this time at a slower pace. As it nears the levels of the previously formed low (Adam), the price is rejected from falling lower. A second, longer-lasting and thus wider bottom is formed as a “U” shape. This bottom is called Eve.
The pattern is confirmed if the price surges past the heights it reached after the rebound of the first bottom – Adam. This is when traders can predict that the price will start rising.
Adam and Eve double top signifies the end of a bull trend. Its shape is a mirror image of the Adam and Eve double bottom pattern.
The first top (Adam) is narrow and pointed, with a strong price rejection at the peak, and is usually accompanied by high trading volume. It forms the shape of an inverted “V.” After this first top and the following sell-off, the price picks up and starts forming the second top (Eve). The shape of Eve is rounder and wider than that of Adam. It is common that the price does not reach the same heights as the first top, thus forming a lower high.
The pattern is completed and confirmed if the price starts declining after Eve.
The pointed and the round top can sometimes be in the opposite order: Eve is formed first, followed by Adam. This happens quite rarely, though.
Recognizing patterns is a good way to spot price shifts in cryptocurrency markets. Read our other articles to expand your knowledge, learn about the tools at your disposal and to become a more successful trader.