What Reversal Patterns Show Us
Reversal patterns are the opposite of continuation candlestick patterns. While the latter signal that the prevailing trend is likely to continue after a temporary pause is finished and the breakout is confirmed, reversal patterns are pointing towards an impending change in the trend direction. Also, reversal patterns need more time to form than the continuation formations as it is easier for the market to continue in the same direction than change its course.
For instance, the sellers were successful in pushing the market lower up to a point where they started feeling exhausted, which provided the buyers with an opportunity to initiate a change in the trend direction. As such, they provide traders with an opportunity to initiate a new trade as the reversal will start a new trending movement.
For the reversal to take place, the prerequisite is the existence of a previous trend, meaning we can’t classify a start of a new trend as a reversal if the market trades sideways prior to the reversal. You see in a photo below that the market changes the trend direction through the double top reversal pattern.
Although reversals start with a breakout, usually of a strong resistance/support, there are signs prior to that point that signal an impending change in the trend direction. While the trend is characterized by a series of the lower highs and lower lows (downtrend), or the higher highs and higher lows (uptrend), we may see signs of weaknesses in the dying stages.
For example, as the head and shoulders pattern forms, the series of the higher highs is broken with the third peak, which comes at a lower price than the previous one. Alternatively, in the case of a double bottom, the sellers fail to push through the support by creating the equal low and not the lower low.