BEARISH CANDLESTICK PATTERNS – Trading Ideas

Japanese Candlestick Patterns: An Effective Tool for Price Action Signals. Continuing our series on Japanese candlestick patterns, today’s article will introduce the second type of candlestick pattern—the bearish candlestick pattern. Additionally, we will explore some of the most common bearish reversal patterns.

1. BEARISH CANDLESTICK PATTERNS

Japanese candlestick patterns were developed by a Japanese trader in the late 18th century for trading rice. Over time, they became the foundation of modern candlestick patterns. Steve Nison first introduced Japanese candlestick patterns to the Western world through his book Candlestick Charting Techniques, published in 1991.

Japanese candlestick patterns formed by multiple individual candles are categorized into two types: bullish patterns and bearish patterns. Once you have a fundamental understanding of Japanese candlestick patterns, it’s essential to dive deeper into bearish candlestick patterns, which indicate that an ongoing uptrend is nearing its end and may reverse into a downtrend.

In this article, we will explore four of the most common bearish reversal candlestick patterns and how to trade them effectively.

2. COMMON BEARISH REVERSAL PATTERNS

Bearish reversal candlestick patterns can consist of a single candle or a combination of multiple candles. Similar to bullish reversal patterns, bearish reversal patterns must form at the end of an uptrend or during price consolidation after an uptrend. Otherwise, they are considered continuation patterns rather than bearish reversal patterns.

2.1. Bearish Engulfing Pattern

The Bearish Engulfing pattern signals a reversal of the uptrend and indicates that prices are falling due to strong selling pressure from the bears. The structure of the Bearish Engulfing pattern is distinctive and easy to recognize, as its name suggests. This pattern consists of a bullish candle followed by a larger bearish candle that completely engulfs the previous bullish candle.

This is an example where the price forms a Bearish Engulfing pattern after an uptrend has ended and the price is in a consolidation phase. When this engulfing pattern appears, it is advisable to exit any previous buy positions. Additionally, you may consider entering a sell position. If you choose to sell, set a stop-loss at the nearest resistance level and a take-profit target at the nearest support level.

Similar to the Bullish Engulfing pattern, the strength of the Bearish Engulfing pattern depends on the size difference between the two candles—the greater the size difference, the stronger the sell signal.

2.2. Hanging Man Pattern

Another popular bearish reversal pattern is the Hanging Man pattern, also known as the “Hanging Man Candle.” When it appears at the end of an uptrend, this reversal pattern signals weakness in the ongoing price movement, indicating that the bulls attempted to push prices higher but failed to sustain the momentum.

The Hanging Man candle has a small body, meaning the opening and closing prices are very close. The lower wick must be at least twice the length of the candle body, while the upper wick is either non-existent or very small.

Visually, the Hanging Man pattern closely resembles the Hammer candlestick pattern. The key difference is that the Hanging Man appears at the peak of an uptrend and serves as a bearish reversal signal.

To trade the Hanging Man pattern, consider the following factors before entering a position. First, the trading volume should be higher than usual. Second, the lower wick should be followed by bearish momentum. Traders should only execute a trade after a Hanging Man pattern appears if these two conditions are met.

You can enter a sell trade on the candle following the Hanging Man pattern or exit any previous buy positions. Traders should place a stop-loss at the most recent high and set a safe take-profit target at the nearest support level.

2.3. Evening Star Pattern

The Evening Star candlestick is a reversal candlestick pattern used by traders as a reversal signal. The evening star pattern consists of three candles. The first candle is bullish (green). The second candle has a small body, in other words, the open and close prices are close together. Finally, the third candle is bearish with the close price being lower or 50% of the first candle. Ideally, the second candle should be a doji.

Traders can enter a trade on the candle following the Evening Star pattern if the price drops below the closing price of the third candle. You can set the stop loss at the nearest peak. The take profit level can be at the nearest support level.

2.4. Dark Cloud Cover Candlestick Pattern

The Dark Cloud Cover candlestick pattern—also known as the bearish reversal pattern—forms at the end of an uptrend and signals a weakening trend. This pattern provides a strong selling signal.

The structure of this reversal pattern consists of a bullish candle followed by a bearish candle. The first candle is a bullish one with a long body. The second candle opens above the closing price of the first candle and closes below the 50% mark of the first candle.

Traders enter a trade after the price drops below the closing price of the final candle in this reversal candlestick pattern. The stop loss is set at the nearest highest price.

3. SUMMARY

The reversal candlestick patterns introduced above all provide bearish reversal signals. Remember, if they do not appear at the peak of an uptrend or when the price consolidates after an uptrend, they are no longer considered bearish reversal patterns.

Candlestick patterns are useful tools for traders looking to predict market reversals. However, by combining them with other indicators, their reliability can be significantly improved. This helps you avoid false breakouts and misleading reversals.

Wishing you successful and profitable trading!