Profiting from crypto reversal patterns
10 Nov 2020
A hammer is a reversal pattern that occurs at the bottom of the downtrend.
In a sea of trading formations, we always look to identify those that have the best chance of bringing us profits. Some elements that define a good trading opportunity, amongst others, are low risk, well-defined setups, and easily identified patterns. All of these elements are present in reversal patterns, and for these reasons, they are considered extremely powerful.
Hence, in this blog post, we look at three powerful crypto reversal patterns that can help you improve your trading process and profitability.
A hammer is a reversal pattern that occurs at the bottom of the downtrend. For a hammer candle to take place, the digital coin has to create a new low - a price lower than the previous lows - before it surges higher within the period to close near the opening price.
It is important that the close is near the opening price, it makes the candle more powerful. As seen below, hammers always have a small real body and a long lower shadow.
Hammer candle is one of the most powerful candle formations out there. The reason is simple: The way it is created sends a signal that the downtrend may be finished and the bulls are now in control since they forced a higher close. A high volume is also a positive sign that the reversal may start taking place with the hammer candle.
A shooting star candle is the exact opposite of a hammer. Unlike it, it is formed at the top of the uptrend and it signals the bulls’ exhaustion. The candle always has a long upper shadow and a small real body near the low of the day.
Opposite of the hammer, a shooting star sends a signal that the uptrend is in the final stages and that the bears are assuming control. There should be a new high before the price action is pushed lower on strong selling pressure. The lower close signals a stronger version of the shooting star formation, especially if the close occurs almost at the bottom.
More experienced crypto traders prefer to wait for the next candle, after a shooting star, and see whether the trend reversal is confirmed with another red bearish candle. Those who prefer a riskier crypto trading approach can open the trade immediately after the shooting star is established.
Engulfing Candlestick Pattern
The bullish and bearish engulfing candlestick patterns also belong to the family of reversal patterns. Both are defined by two candles and signal that the previous prevailing trend may end soon and a reversal should start taking place.
The bullish engulfing pattern occurs at the bottom of the downtrend. The first (bearish) candle has a relatively small body and short wicks. Next to it, the bullish engulfing candle must completely overwhelm the real body of the previous candle.
Bearish engulfing works the other way around. It is formed at the top of the uptrend, and the second bearish candle engulfs the first smaller candle. It is important to note that it is mandatory for the closing price of the second bearish candle to occur below the prior candle’s low.
These two candlestick formations send the same message as a hammer and shooting star - the previous trend is now ending and we may be provided with a reliable trading opportunity to capitalize on the expected trend change.
Trading crypto reversal patterns
No matter which of these patterns you select, all of them are applicable in a similar fashion. To demonstrate how to trade reversal patterns, we will take a closer look at the shooting star formation that is formed on the daily BTC/USD chart.
There is a clear uptrend in the price action as there is a series of higher lows and higher highs. At one moment, the bulls print a fresh high. However, they are unable to force a high close and the price action rotates lower to create a shooting star formation.
The long wick and a short body, with a close near the low of the candle, signal that the bears are assuming control. The start of the new trend is confirmed with the next bearish candle.
As stated in the outline, there are two different moments after which you can initiate the selling trade. The first is immediately after the formation of a shooting star candle, which is riskier but also more profitable.
The second approach assumes waiting for the next candle before initiating a trade. The apparent downside is that the entry price is not as good as if it had opened the trade higher. The stop loss should always be placed above the previous high.
In this particular case, we decided to take the first approach. We are selling BTC/USD for around $11,200 after we spotted a shooting star candle that ticks all the boxes. We are risking approximately 600 pips as the stop loss is set above the previous high.
Setting the take-profit order depends on your trading approach. In this case, our risk/reward ratio is 2:1, meaning we are risking 600 pips to make 1,200. Eventually, the price of Bitcoin dips lower to hit our target.
This is a great example of how powerful reversal patterns are. Spotting reversal signals soon can help us enter a good trade soon, and at a better price than the others.
Are you ready to put your skills to the test?
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