Chart Patterns - Piercing Pattern
Type: Bullish Reversal Pattern
Appearance: The Piercing Pattern consists of a long body black (down) candle, followed by a white (up) candle which opens below the first candle's low. This means there is usually a gap between the first candle's close and second candle's open, although in forex this is not a necessary pre-condition. The second candle then penetrates deep into the body of the first candle, signaling a shift in market sentiment. The piercing pattern is the exact opposite of the dark-cloud cover pattern.
Typical Duration: 2 candles
Description: The Piercing pattern is a bullish reversal pattern, meaning that it normally comes at the end of a down-trend, and signals the beginning of trend change. Please note that a "trend change" is not necessary a "trend reversal", it could just mean a pause or pull-back of the current down-trend. The rationale behind it is that the bears are in control during the down-trend and are getting overly confident in their trend's invincibility (exuberance). Sheep investors are drawn into one final sell-off causing the long black candle. Being the last in, these investors are promptly caught in some strong buying pressure. This causes many of them to cover their short positions in what is commonly known as a "short squeeze". They are forced to liquidate their positions, which results in even more buying, pushing the long white candle to penetrate beyond the 50% point of the previous bear candle. The sellers have been exhausted, and they buyers are starting to see the low price as a bargain, and entering long positions. Long story short, the requirements are:
- Long black (bear) candle
- A down-gap on the open of the next candle (although this is not necessary when applying the Piercing pattern in forex)
- A long white (bull) candle that closes above the half-way (50%) point of the previous bear candle's real body
An example piercing pattern is illustrated below:
Much like the dark-cloud cover pattern, the piercing pattern also has several "additional" conditions which are not required, but can make it a more reliable reversal signal:
- The further the bull candle penetrates beyond the required 50% mark, the more control the buyers have gained, increasing the probability of further upside in price. If it closes above the previous black candle's open price, then it becomes a bullish engulfing pattern, one of the most reliable bullish reversal patterns around.
- If the pattern occurs inside a signifcant support zone, the chances of it being a tradable reversal improve.
- The shorter the shadows are, the more reliable the pattern becomes, signaling a more sudden and violent reversal (shaved bottoms and shaved heads are ideal).
Strengths: The possibility of trading this pattern with a very favorable reward:risk ratio is its main strength, and can arguable overcome its relatively poor winning percentage as compared to similar patterns such as the engulfing pattern, particularly so if any or all of the 3 "additional" conditions are met.
Weaknesses: Since gaps are somewhat rare in the forex market due to its 24/5 nature, we have to deal with very few real signals produced by this pattern, or we have to lower our standards and go for some trades which do not meet the piercing pattern's strict definition. Either way, overall performance is reduced as compared to trading this pattern in other markets with more frequent gaps.
How to Trade It: While it is not recommended to trade the piercing pattern on its own, partially due to its lack of an obvious take profit strategy, when combined with other analytical tools, the piercing pattern can be a very good friend to forex traders. The main things to look for, besides the 3 additional conditions above, is some logical price where your trade should be considered successful enough to liquidate. This can be based on whatever analysis you have found to be reliable. With that in mind, you wait for the formation of the piercing pattern to be complete at the close of the white candle, and enter a long position while placing a stop-loss order far enough below the low point of the pattern to minimize the chances of getting the stop-loss order filled by some random market movement.
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