Momentum, Reversals, and Bar Patterns

Last week AJ Brown from TradingTrainer.com gave us a great article to 'chew on' covering OTM near-term vertical debit spreads. The response was pretty good, but I think we'll get him an even greater number of comments with this article on momentum, reversals, and bar patterns. Please enjoy the article and if you haven't done so yet, I recommend you check out AJ's training videos as you'll learn a TON!

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Every day’s bar tells us something about what to expect the next trading day. In other words, today’s bar affects tomorrow’s bar. So how do we know what that effect will be?

Not every bar will give you clear insight into where the market is headed. But there are certain bar patterns that are more informative than others. Allow me to share a few of these bar patterns with you.
You can often determine if the next trading day is going to be an up day or a down day by looking for a “key reversal up” or a “key reversal down.”

A key reversal up is when today’s low is lower than yesterday’s low, but the close is higher than yesterday’s close. When this happens, the next trading day will usually be an up day. Here’s a chart showing a key reversal up :

A key reversal down is when today’s high is higher than yesterday’s high, but the close is lower than yesterday’s close. When this happens, the next trading day will usually be a down day. Here’s a chart showing a key reversal down:

During a key reversal up, the bears try their best to push the price down. But then the bulls come back strong and drive the price higher than the previous day’s close. This indicates the price will go even higher on the next trading day.

During a key reversal down, the bulls try their best to push the price up. But then the bears come back strong, taking back all the the price gains and then some. This indicates the price will be headed lower on the next trading day.

Two more bar patterns that can be used to determine where the price of a stock is headed are a doji with an intraday low and a doji with an intraday high (a “doji” is a one-day bar with virtually the same open and closing price).

A doji with an intraday high is sometimes referred to as “Lincoln’s Hat.” Here is a chart of a Lincoln’s Hat bar pattern:

As you can see here, the price opened and closed at almost the same exact spot. But the price ran up quite a bit before running out of steam. The pattern looks like Lincoln’s famous top hat.

When you see a pattern like this, you can be reasonably sure the price will go lower on the next trading day. And, of course, if you see a cross pattern (an upside-down Lincoln’s Hat), then the price will probably go higher the next trading day.

In every case I’ve shared here, the momentum from one day spills over to the next.

One last note: When there is very little trading volume, then these patterns are not quite as reliable. But the more volume there is, the more reliable these bar patterns become.

Best regards always,
A.J. Brown

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18 thoughts on “Momentum, Reversals, and Bar Patterns

  1. Hi AJ,
    Its always a pleasure to see and read your articles. Not only are they easy to understand, but are always content rich. Thanks much for your continued contributions to the trading community.
    Peace.
    John Zelko

  2. Hello,
    I have a question with respect to this.

    Say for example -: for key reversal down
    Market higher: 40 for yesterday and 50 for today
    Market lower: 36 for yesterday and 35 for today

    For up reversal
    Market higher: 40 for yesterday and 50 for today
    Market lower: 36 for yesterday and 35 for today

    Now, IF you analysis by data its one and same. then on what basis one should analysis market, whether it will move towards up or down or next day.

    Just have a look and let me know so that i can get clear picture about it.

  3. Hello,

    I just need more clarity on this. Say for example

    key reversal down

    Higer 40 for yesterday and today 50
    Lower 36 for yesterday and today 35

    key reversal up
    Higher 40 for yesterday and today 50
    Lower 36 for yesterday and today 35

    As per the above chart, for the first example market is expected to go down for next day and for the second example it is suppose to go up. if you analysis my example both stand one and the same. So on what basis we should analysis about the market movement? How can one predict whether market 'll go up or down? just help me to understand this concept

  4. So according to this, we could see a trend reversal signal in gold today. It has a lower low than yesterday, but we need it to close higher, on higher volume, than yesterday. Right?

  5. i agree with jeff diercks. candle sticks are much easier to read when doing technical analysis. i always use them when trying to discern patterns

  6. The key reversals up and down are very similar to bullish and bearish engulfing signals using candlestick charts. These signals can work extremely well after a significant run up or down, and even better when used in conjunction with another indicator such as RSI divergence or 20 day bollinger bands. For example, if I see a stock that has dropped heavily over a period of time and is a long way from the 72 day moving average with RSI divergence, a green candle outside (or at least mostly outside) the 20 day bollinger bands and a bullish engulfing signal then I will be on it without hesitation. It doesn't have to have all of these requirements, but the more the better. And it works the opposite way for short trades.

    Happy Trading.

  7. Quick and simple. Maybe a % of the time it is valid would encourage a sure priority of storage in the memory. f

  8. Simple and concise! I like your reversal set up explanations, very user friendly. I do wish you had used candlesticks in your charts however. Candlesticks are perfect for depicting in "pictures" what you have skillfully described with words.

    -greg

  9. Nice article! I would suggest however that candlestick charts could make these key reversals even easier to spot. OHLC bars in my opinion are tougher for new traders.

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