When flipping through charts at the end of the day or in the evening when you are looking for trading ideas, one of the best candle formations that I like to take note of is when I encounter a possible reversal candle. You can do this on any time frame chart, but I will generally stick to daily or weekly charts when looking for positional or possible swing trade candidates.
When I look at possible weekly reversal candles, I like to see the stock act strongly in the opposite direction in the first couple of days of the subsequent week … basically, I’m looking for a type of a short-squeeze in that particular stock.
Delta Air Lines’ weekly chart is an example of that type of candle pattern formation …
There is no real secret in trying to find a good possible reversal candle … you want to see essentially some type of sign that a move of the past several days or weeks is possible exhausted. For example, on the DAL weekly chart, you can see that last week saw a hammer candle form that made a new multi-week lower low, but that before the week was complete, price pushed back to end only 7c lower than the prior week’s close. That is a good sign that DAL has possibly seen the total amount of sellers exhausted in the near term.
The price action the first two days of this week are in my eyes, confirmation of that possible weekly reversal … Monday and Tuesday of this week saw price gap up above the prior three weeks’ high and hold that level. In essence, anyone that shorted DAL the past three weeks is now offside, and forced to cover if price continues to move higher.
I have scans that I run that help me find possible reversal candles … there is no “set” definition for a possible reversal candle, but I have scans built for daily, weekly and monthly time frames.
Here is a look at my criteria for a possible daily reversal candle …
AAPL – Daily Chart
For daily charts, I want the prior candle’s low to be a new 5 day low, and I want the reversal candle to push to a new lower low, but to then close back above the prior candle’s low (typically that means back inside the body of the prior candle). For weekly and monthly scans, I look for only 3 prior candles to set-up the possible reversal candle.
Here is the current weekly scan I ran tonight that lists all of the stocks that met the weekly reversal scan criteria for last week’s candle, and the price action so far that week has not broken to a new lower low …
You can see that there is currently 48 stocks of my approximately 600 stock scanning list that meet that weekly criteria. I rank them based on the strength of the current week’s stock performance.
Here is the scan results looking at the daily time frame and looking for a possible reversal candle being made with today’s price action …
73 stocks meet the possible scan criteria on the daily time frame (i.e., yesterday’s daily candle made a new 5-day low and today’s candle made a new lower low, but closed above yesterday’s low).
WEAT – Daily Chart #1
The daily chart from the Wheat ETF is an example of a possible great daily reversal candle … I say that because not only did today’s candle push to a new low, and then get back above yesterday’s new 5-day low, but in this case it actually closed above the prior day’s high (it actually closed at the high from two days ago). To me, WEAT can firstly be a name that at the least is a good candidate for intra-day trading … after a large range move like today, I would be a bit leery of buying for a swing/positional trade at current levels – I would rather see a smallish inside candle over tomorrow or the next couple of days to convince me that there is not likely to be a big move in the opposite direction.
WEAT – Daily Chart #2
When I look at a zoomed out daily chart for WEAT, I can see that it could be a good candidate for a counter-trend move considering it has been going straight down for 2 months of late … I live in the prairies of Canada, and it has been drought conditions, so I have to think that grain/wheat prices are more likely to move higher than to move lower heading into the end of harvest season. The last 21 days has seen price move sideways and it seems like the sellers are running out of ammunition … maybe a good 5-8 day bounce is in store for WEAT.
If you don’t have TC2000 and therefore can’t set up scans like this, you can still keep your eye open for possible reversal candles …
USO – Daily Chart
You can see from the above daily chart for USO, my scan would have picked up those two reversal candles in late August, but traders should always be on the look-out for what could appear to be a possible reversal candle even if the candle setup does not meet say a 5-candle set-up. Look at the daily candle for USO for this past Monday … heavy selling this past Friday led to a move to new lows at Monday’s open, but low and behold, sellers could not keep price heading lower. Price closed off of the lows and back into the body of Friday’s large range candle. My scan did not pick up that possible reversal candle because Friday did not register a new 5-day low (it was only a new 4-day low). Nonetheless, if you were flipping through charts on Monday night, you could have spotted what might have been a good reversal candidate, and therefore, you could have been watching oil for some follow through to the upside today/the rest of this week.
Here is a list of stocks that made a possible reversal candle on Monday, and did not have the Monday low taken out during today’s price action (i.e., the possible reversal candle is still in play).
Bottom Line – part of learning to become a profitable trader is trying to find good entry points for your trades. I have found that finding stocks that have exhausted a move (typically a counter-trend move), can provide higher winning odds, and greater profit potential, than just trying to buy stocks that have momentum currently in a multi-day run.
Cheers … Leaf_West