From the May 01, 2007 issue of Futures Magazine • Subscribe!

Spotting reversals

Using a candlestick chart can help you to spot an early reversal long before traders who don’t use them. The red semi circle highlights a classic candlestick signal called a Bearish Engulfing Pattern, in which a black real body engulfs, or wraps around, the immediately preceding white real body. This visually displays the sellers, via the black real body, gaining control over the buyers.

The market then descended until the emergence of the white real body at the green arrow. This candle line gave a small clue that the prior downtrend was losing drive.

While candles are available on most charting packages, many traders are using them incorrectly. For example, a candlestick signal requires a trend to reverse. In the bearish engulfing pattern discussed above, there was a small rally preceding the pattern. Note the blue semi circle. Isn’t that a Bearish Engulfing Pattern? The pattern is correct — a black candle wrapping around an immediately preceding white candle. But note the trend immediately preceding it. Silver was trading laterally (what the Japanese call a “box” range). As such, there was no uptrend to reverse. And therefore, one should not view this pattern as a classic Bearish Engulfing Pattern.

Of course, even with a classic Bearish Engulfing Pattern, it doesn’t mean the market will always reverse; that is what protective stops are for.

A Japanese proverb states, “He who is well prepared has won half the battle.” And there is no better weapon — when used correctly — for your trading battles than candlestick trading tactics.

Steve Nison, CMT, is the president of Candlecharts.com, which has daily futures market commentary. E-mail Tracy@candlecharts.com for details.

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