A pattern is a chart pattern that forms when a small black , showing a , is followed the next day by a large white , showing a , the body of which completely overlaps or engulfs the body of the previous day’s .
Breaking Down 'Bullish Pattern'
A pattern is not simply a white , representing upward price movement, following a black , representing downward price movement. For a pattern to form, the stock must open at a lower price on Day 2 than it closed at on Day 1. If the price did not gap down, the body of the white would not have a chance to engulf the body of the previous day’s black .
Because the stock both opens lower than it closed on Day 1 and closes higher than it opened on Day 1, the white in a pattern represents a day in which bears controlled the price of the stock in the morning only to have bulls decisively take over by the end of the day.
The white of a pattern typically has a small upper wick, if any. That means the stock closed at or near its highest price, suggesting that the day ended while the price was still surging upward. This lack of an upper wick makes it more likely that the next day will produce another white that will close higher than the pattern closed, though it’s also possible that the next day will produce a black after gapping up at the opening. Because patterns tend to signify trend reversals, analysts pay particular attention to them.
Investors should look not only to the two which form the pattern but also to the preceding . This larger context will give a clearer picture of whether the pattern marks a true trend reversal.
patterns are more likely to signal reversals when they are preceded by four or more black . The more preceding black the candle engulfs, the greater the chance a trend reversal is forming, confirmed by a second white closing higher than the candle.
Acting on a Pattern
Ultimately, traders want to know whether a pattern represents a change of sentiment, which means it may be a good time to buy. If increases along with price, aggressive traders may choose to buy near the end of the day of the candle, anticipating continuing upward movement the following day. More conservative traders may wait until the following day, trading potential gains for greater certainty that a trend reversal as begun.