How do you identify reversal or continuation signals with candlestick charts?

1 What are reversal and continuation signals?

Reversal signals are candlestick patterns that indicate a change in the direction of the prevailing trend, either from bullish to bearish or vice versa. Continuation signals are candlestick patterns that confirm the strength and direction of the existing trend, and suggest that it will persist for a while. Both types of signals can help you to enter or exit trades at optimal points, depending on your risk-reward ratio and time horizon.

2 How to spot reversal signals with candlestick charts?

Candlestick charts can provide traders with valuable reversal signals, with some of the most reliable ones being Dojis, Hammers and Hanging Men, and Engulfings. A Doji is a candlestick with a very small or no body, and equal or almost equal upper and lower shadows, indicating indecision and uncertainty in the market. A Hammer has a small body and a long lower shadow, while a Hanging Man has a small body and a long upper shadow; both indicate rejection of lower or higher prices. An Engulfing is composed of two consecutive candles where the second completely covers the first one; a bullish engulfing signals a reversal from bearish to bullish, and vice versa for bearish engulfings. These signals can be used to identify potential reversals at the end of trends.

3 How to spot continuation signals with candlestick charts?

Continuation signals with candlestick charts are less frequent and less obvious than reversal signals, but they can still provide valuable information about the trend. A marubozu, for instance, is a candlestick with a large body and no or very small shadows. This indicates a strong and decisive movement in the direction of the trend, suggesting that the trend will continue for a while. Alternatively, a harami is a candlestick pattern that consists of two consecutive candles, where the second candle is smaller and fits inside the first one. This suggests that there is a pause or consolidation in the trend, before it resumes after the break. Further, three white soldiers and three black crows are candlestick patterns that consist of three consecutive candles of the same color, each candle having a larger body and a higher or lower close than the previous one. This signals strong and sustained momentum in the direction of the trend, meaning that it will persist for a while.

4 How to use reversal and continuation signals with candlestick charts?

Reversal and continuation signals with candlestick charts can help you to improve your trading performance, but they are not foolproof or standalone indicators. You should always use them in conjunction with other technical tools, such as trendlines, support and resistance levels, moving averages, oscillators, and volume. You should also consider the context and the timeframe of the signals, as they may vary in significance and reliability depending on the market conditions and the trading horizon. Finally, you should always have a clear trading plan, with predefined entry and exit points, stop-loss and take-profit levels, and risk management rules.

5 Examples of reversal and continuation signals with candlestick charts

To demonstrate how reversal and continuation signals with candlestick charts work in practice, let's look at some examples from the daily chart of Bitcoin (BTC/USD) in 2020 and 2021. In March 2020, Bitcoin formed a bullish engulfing pattern at the bottom of a sharp downtrend, signaling a reversal from bearish to bullish. This was confirmed by a break above the descending trendline and the 50-day moving average, as well as a surge in volume. Consequently, Bitcoin entered a strong uptrend that lasted for several months. In September 2020, Bitcoin formed a doji candlestick at the top of an uptrend, implying indecision and uncertainty in the market. This was followed by a bearish engulfing pattern, indicating a reversal from bullish to bearish. The pattern was validated by a break below the ascending trendline and the 50-day moving average, as well as a decline in volume. Subsequently, Bitcoin entered a correction that lasted for several weeks. In October 2020, Bitcoin formed a harami candlestick pattern at the bottom of the correction, suggesting a pause and consolidation in the downtrend. The harami was followed by a bullish engulfing pattern, indicating a reversal from bearish to bullish. This was confirmed by a break above the descending trendline and the 50-day moving average, as well as an increase in volume. As a result, Bitcoin resumed its uptrend that reached new highs in 2021. In January 2021, Bitcoin formed a marubozu candlestick at the top of an uptrend, showing strong and decisive movement in the direction of the trend. This was followed by two more green candles forming a three white soldiers pattern, indicating strong and sustained momentum in the direction of the trend. The pattern was validated by a break above the previous resistance level and the 20-day moving average, as well as high volume. Finally, Bitcoin continued its uptrend that reached new highs in 2021.

6 Here’s what else to consider

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