Key Reversal Pattern

The Key Reversal Candlestick Pattern is a simple yet powerful pattern that can generate trading signals. It’s not just an indicator, but it should be considered part of your Automated Trading Systems (ATS). This article will show you how to create and use this cactus-like formation with success!

First, let us introduce what we’re going against: The High And Low Bar Reversal. Analyzing chart patterns to look at them from different angles before deciding if they might work well together on one screen makes understanding their relationship more intuitive than ever.

What is the Key Reversal Bar pattern?

A one-day reversal results when a market achieves new highs and lows, ideally at the same time. The phrase “an extreme intraday sentiment change” refers to dramatic shifts in trader sentiment over short periods – usually not more than two or three days long but can last up to four weeks before reversing again on some occasions (known as solid trend reversals).

That is to say, the market has seen an extreme shift in sentiment over the trading day, and a reversal appears likely.

A key reversal helps to indicate the reverse of a trend. When prices go up, they might go up to a higher high and then close less than the price before. In a down market, prices will open below or above the closing price from the back.

Identifying short-term changes in direction on daily candles for swing trading is one example of this concept’s use. This method can also be used when looking at shorter and longer bar intervals. 

Still, it’s not always reliable because stock prices often move slowly over periods ranging from hours up to years before making a significant change or reversal rather than suddenly changing course every day.

How Can You Recognize a Key Reversal Pattern?

An outside day (hammer candle or pin), for example, is the most typical pattern of a key reversal. The form of these bars might vary, but they often have structural elements in common that make them appear alike visually and at various stages throughout trend reversals, when prices are leveling off between drops/rises before making new highs once more.

Reversal bars will show up when critical highs or lows have been reached in an up-trending market. There are areas on the chart where the price of the stock goes up. These are called support zones. 

The chart shows these zones as points where people bought stocks at lower prices before. They could be good places to buy more stocks if you want them cheaper.

On the other hand, Reversal bars provide traders with a wonderful approach to enter the trend, as they offer a visible place for a stop and considerable profit if the trend is strong enough. This is an excellent risk-reward situation.

How to interpret Key Reversal Bar pattern?

A key reversal occurs at the top of an uptrend, indicating that prices are making higher highs. The bar with a higher high than yesterday’s open is followed by one where they close lower than before as well- representing possible exhaustion among buyers or sellers depending on how you look at things.

A “key” event happens when traders’ optimism about stocks runs out – usually because there has been too much-buying pressure pushing them up without any sign from bears willing to sell off their investments meaningfully enough again soon (or ever).

A two-bar reversal pattern means that the market’s sentiment has been rejected. This type of trading is more credible when it appears on both sides. These are significant pivots or turning points where investors often think about their strategies before returning to stocks from below ground level with fresh optimism following an upswing from below ground level.

All time frames and markets have two-bar reversals, albeit they are not tradeable. There must be a powerful trend in action to trade them, and you should look for reversal signals at swing points. Value areas where you may buy low or sell high/expensive are known as swing points.

Key Reversal versus Engulfing candlestick

It’s not a fluke that a two-bar reversal pattern materialized. It’s the consequence of extremely powerful market optimism, and it reflects how investors perceive what they see in their investments, whether it’s bullish or bearish. The engulfing candlestick indicates that there are two bars, which implies you’ve been going from one side to the other regarding your decision – this might also suggest a change has taken place!

A pattern that has a difference between it and an engulfing candlestick formation is the second bar. In some cases, it does not have to be more than the other price. In some cases, they might stand apart from each other.

The difference between these two patterns is their shapes. 2-bar Reversal Patterns have lower highs, and Engulfing Candles tend to have taller tops. So they both need more space before they can turn bullish or bearish.

Backtesting a Reversal Strategy

You’ll discover how to create and utilize this indicator in your automated trading systems now. The High and Low Bar Reversal is the first step.

The Reversal Bearish Bar occurs when:

Today Price High > Yesterday Price High                       
and
Today Price Close < Yesterday Price Close

The Reversal Bullish Bar occurs when:

Today Price Low < Yesterday Price Low                       
and
Today Price Close > Yesterday Price Close

There are several patterns that appear frequently in this pattern, which is why it isn’t particularly remarkable. We develop a little trading system to test these notifications anyhow.

A short and long position is opened with the Trading System. We maintain a position for X days without having placed a stop-loss. We keep our positions open for X days. The Daily – SPY ETF was used in this test.

strategy backtest key reversal pattern
strategy backtest key reversal pattern

The results show the inconsistency of this strategy. As we can see, only the long side has an acceptable percent of profitable trades. This means that the price reverses only after a bullish pattern, but not strongly enough. In fact, the average net profit is too small.

So this pattern is not significant even when considered alone. The price doesn’t react fast after. Let’s go to analyze the more specific pattern.

Backtesting a Key Reversal Strategy

The Key Reversal Bearish Bar occurs when:

Today Price Open > Yesterday Price Close
and
Today Price High >Yesterday Price High
and
Today Price Close < Yesterday Price Low  

The Key Reversal Bullish Bar occurs when:

Today Price Open < Yesterday Price Close
and
Today Price Low >Yesterday Price Low  
and
Today Price Close > Yesterday Price High

The price gap of the key reversal bars opens first. So, this pattern is only for daily charts since intraday gaps are difficult to spot on a day-by-day chart.

A positive or negative pattern in the price movement signals that market sentiment has altered. You may observe the strength of the price move that suggests a change in direction.

This is a typical pattern, and it resembles the Outside Day Bar and Pin Bar. There are two successive patterns in this chart: Outside Day and Key Reversal at the same time.

3-key-reversal-pattern-outside-bar

We can discover that the short side does not work if we build another trading system to test this pattern. The long side is profitable, but there aren’t enough total trades, and some filters are difficult to insert.

excel spreadsheet results key reversal strategy
excel spreadsheet results key reversal strategy

Why did we only last five days in the seat? We wanted to see if the price reacts quickly following a pattern.

If you want to utilize this design as a filter, you’ll need to know how quick the price adjusts. We can see that the outcomes got better if we keep the position for many days.

results with hold position reversal pattern
results with hold position reversal pattern

Volume filter

We may also consider using a volume filter for educational reasons. A significant price movement characterizes the Key Reversal Pattern. If institutional traders open big bets, the price may reverse direction. 

You’ll see an increase in volumes if this is the case. To add this filter, you must first create a Volume Moving Average.

MA_Volume = Average(Volume, 20);

When the daily volume is greater than his 20-day moving average, the pattern is accurate.

Conclusions

The Key Reversal Pattern might be used as a filter, but it doesn’t happen often enough.
We test the long side of this system over 20 years, $10,000 per trade with no stoploss and a 5-day exit strategy for each trade in 18 U.S. major stocks.

If you use the key reversal as a filter, keep in mind that the total number of trades will fall because this pattern is rare. It’s also important to consider the trend; the reversal is only noise in a range-bound market.

The horizontal line represents support or resistance, which is crucial since the pattern near this area is more robust. As a discretionary trader, you can build a market scanner for a significant stock portfolio.

TradeStation MultiCharts EasyLanguage Code Indicator
TradeStation MultiCharts EasyLanguage Code Indicator with input
TradeStation MultiCharts EasyLanguage Code Indicator with input

Resources:

TRADERPEDIA: Key Reversal Pattern

Disclaimer this is not a financial advice.