How to Identify Market Reversal Using Piercing Pattern?

14 Oct 2021  Read 1964 Views

Trading’s exciting; adrenaline inciting. No investor must miss out on this amazing feeling. Today, we present to you a top-notch tool to identify a potential downward to upward trend reversal pattern. This iconic tool is called “Piercing Pattern.” 

It's nothing but a game of two important days where on day 1, a bearish candle is formed which is followed by a bullish candle on day 2. This pattern is mostly used to identify a reversal trend after a prolonged downside. After all, who doesn't want to spot the point of change? Thus, It is a saga of a Bull & Bear collision revolving around the opening & closing prices of the stock. It's easy, and you can identify it effortlessly. 

Let's move forward and understand what the pattern is all about.

What is a Piercing Pattern?

It is like a candlestick pattern with two-day data showing the expected short-term trend reversal from the downward trend towards the upward movement. This pattern consists of 2 major items, the bearish candlestick on day 1, and the bullish candlestick on day 2. The whole pattern relies upon the near high opening price on day 1, followed by the near low closing price on day 2, portraying the expectations of a downward trend. 

This candle has an average or large-sized trading range. A bearish candle is usually red or of any dark colour signifying danger or downtrend. In contrast, a bullish candle is green or any other colour, indicating the higher closing price or the upward trend for that period. 

After understanding what a Piercing Pattern is, let's take a look at how to understand these patterns.

How to identify Piercing Patterns?

Firstly, one needs to keep in mind that the pattern formulation should consist of 2 candlesticks. The second candlestick should be such that it should start below the low of the day 1 candle (which is bearish in nature). At the same time, it should close at the above portion of the middle part of the bearish candle. 

When the bullish candle on day 2 closes above the center of the bearish candle on day 1, it forms a triangle. Furthermore, it only appears during a downward price trend, and price gaps at the start of day 2 are required. The formation of this pattern is unique as it showcases the reversal trend in the market when it was not accepted to occur.

It also contains a lower gap after the first day's trade, with the second day's trade starting around the low and ending near the high. The closing should likewise be a candlestick covering at least half of the red candlestick's upward length from the previous day.

How does the piercing pattern work?

It is recommended to use this pattern along with other technical tools to confirm the reversal trend in the stock or index. 

This is followed by buyers forcing prices higher to close over 50% of the bearish candle's body. It gives the signal that bears or sellers are losing money at the current price level. Importantly support signals should be used to confirm the pattern while making trade decisions.

The piercing pattern, like the dark-cloud cover, and other trend reversal patterns, is more trustworthy based on where it occurs on the price chart with respect to trendlines, pivot points, support and resistance lines, and other factors. 

A piercing pattern near or on a lower trendline or support line might be used to confirm that the trendline test is more likely to fail. The Piercing Pattern's lowest point can also serve as a support line and a potential place for a protective stop loss.

Key Pointers to remember while trading using Piercing Pattern 

  • When the trader observes the formation of a piercing pattern in the stock or index, they should wait till the preceding bearish candlestick that must follow the high of the first candlestick. 

  • The trader needs to set the stop loss at the lower range of the preceding bearish candlestick. Then before taking the actual positions, the trader should confirm the pattern through other signals. 

  • This pattern is more appropriate for the intraday or swing traders as the trend may get reversed in the long run. 

  • Traders often have two alternatives in the event of a bullish reversal, i.e., They can buy the stock to take advantage of the current upswing or purchase an in-the-money call option with a strike price lower than the current market price.

Advantages of using piercing pattern 

This method is easy to use and implement. Any level of investor or trader can implement this technique. 

This method usually gives a better risk-reward ratio to its investors. If investors observe and understand this technique, they can easily find entry points in the stock or index. 

Disadvantages of using piercing pattern 

The major drawback of this method is that it can only be used for a bullish reversal pattern. And to confirm the reversal pattern, one needs to combine this technique along with oscillators and other technical indicators. 

One cannot wholly rely on this pattern to make trading decisions. It entails analysing the whole market movement rather than simply the candlestick pattern on its own. 

Conclusion

Identifying piercing patterns is quite simple as it consists of two candlesticks; the first one is bearish, and the second one is bullish. You can try this simple technique with other technical tools to observe the pattern in the market to earn better returns in short-term time frames.

If you have already used this tool, let us know in the comment box below. Also, share some pro-tips required to be successful in this trading strategy.

Hope you enjoyed what you learned today!

About the Author: Kanishka Tayal | 9 Post(s)

Kanishka is a finance enthusiast, currently pursuing her master's in Banking and financial services domain. She loves to doodle in her spare time. She is a keen learner and is willing to pursue her career as a financial analyst.

Liked What You Just Read? Share this Post:

Finology Blog / Finance / How to Identify Market Reversal Using Piercing Pattern?

Wanna Share your Views on this? Comment here: