Sohan was planning to start short term trading during the quarantine. Some of his friends were making great returns by placing smart short term trades. Sohan started trading with his friends. One day, the markets reopened, and Sohan asked his friends if he should bet on a trend reversal on a particular stock - they advised him not to. They told him that the signal for trend reversal is possible, but it is not certain - they were making use of an indicator called the 5 bar reversal indicator. His friends advised him to wait a little longer. Sohan was getting frustrated.
Before we figure out why his friends told him to wait, let’s look at a cool trend reversal indicator, that can help you identify the next trend reversal ahead of time. This indicator requires the usage of candlestick charts, so make sure that you understand them with ease.
Now let’s talk about this indicator in detail. As the name suggests, this indicator consists of 5 candlesticks. These candlesticks should occur one after the other, in a succession. Now let’s discuss the shape of the pattern.
Basically, the 5 bar reversal pattern consists of 5 consecutive bullish or bearish candles. Just a quick clarification before we proceed - on a candlestick chart, the white or the green candles are bullish candles, while the bearish candles are black or red in colour.
And bearish candles simply show that the price for that period or day, closed above the levels at which it opened. So, if you spot 5 consecutive candlesticks of the same colour, the 5 bar reversal indicator tells you that a trend reversal will follow. This means that the 5 bar reversal indicator is used to devise counter-trend trading strategies. Cool, right?
Sohan got worried - he was sure that he had studied the pattern very carefully, and the 5 consecutive bullish bars were present, in his scenario. To convince him to not bet on the reversal, Sohan’s friends told him that there is another part to the 5 bar reversal indicator that he is forgetting.
To see what he was forgetting, let’s look at some of the subtleties you should pay attention to, before making a forecast with this indicator.
Firstly, let’s talk about the confirmation of the signal generated by the 5 bar reversal indicator - it will be easier to understand this with an example.
Consider a scenario where you spot 5 bullish candles in succession.
Now, according to our 5 bar reversal indicator, a downtrend will follow the 5th bullish candle, meaning that the 6th one will be a bearish candle. In fact , the 6th candle is actually where you look for confirmation.
Now, this is what you should pay attention to - when the 6th candle is not bearish, then the signal was a false one.
On the other hand, if the 6th candle is bearish, then you must assess the price movement within that period. Did the 6th candle surpass the previous candle?
This is an intricacy that novice traders often miss - if the 6th candle did not surpass the previous candle, then you should avoid creating a position.
Before we move further, let’s revisit Sohan’s story - the sixth candle is what he was missing. In fact, when his friends explained how the 6th candle will be the confirmation of the signal, he studied some historical charts. Then, he proudly went back to his friends and showed them that the trend was actually not reversing, because the sixth candle didn’t even surpass the fifth one.
So how can you use this indicator to enhance your trades?
First thing to pay attention to, is that the 5 bar reversal indicator does not apply to long term trends - so, this indicator will not help you predict long term trend reversals. In fact, it signals short term trend reversals.
It also naturally follows that this indicator can help you enhance your short term trading. Let’s see how.
You have been following the price charts of a security and you are well aware of the market dynamics around its prices. When you spot 5 successive 5 bearish candles, you anticipate a bullish trend reversal. If the 6th candle confirms the reversal, you enter the trade after the confirmation. Again, if you spot 5 bullish candles, you will consequently expect another reversal, before which you can safely exit your trade. This is simple, right?
Indeed it is. But you should also keep in mind that you should not take these signals at face value. As with all other types of candlestick patterns, the 5 bar reversal indicator can also result in false signals. That’s why, it is crucial to pay attention to all the finer details and conditions of such indicators. Additionally, you should always stay aware of the market dynamics around a security, because in some markets, prices move very differently compared to others.
Experience and familiarity come with application of all the knowledge that you acquire. You can start small, and make informed trades online, with Angel One. Visit www.angelone.in to experience effortless digital trading at the hottest exchanges in the market today.