There are many tools and indicators technical traders use to enter profitable trades. While not perfect, these indicators can lend some insight into a market’s future performance by helping traders get a reading on the market’s psychology. One of these technical indicators is the bullish/bearish piercing line pattern in candlestick trading.
The bullish/bearish piercing line pattern is a reversal pattern formed from two candles that follow a trend in an asset’s price movement. The first candle will be characterized by a long candle that continues with a trend. The second candle will open lower/higher than the previous close and move to about 50% of the previous day—the piercing line.
While not as strong a bullish/bearish reversal indicator as an engulfing pattern, the piercing line pattern can be a significant indicator for astute traders because piercing line patterns, in their strictest sense, rarely form on a candlestick chart. However, when they do form, they are solid indicators of a reversal. Like all technical analysis tools, piercing line patterns are best combined with other indicators to maximize their efficacy in assisting in trade decisions.
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Table of Contents
Types of Piercing Line Candlestick Patterns
There are two types of piercing line candlestick patterns: bullish and bearish. While each pattern represents a different kind of reversal, they operate in fundamentally the same way—just in the opposite direction.
Bullish Piercing Line Pattern
A bullish piercing line pattern follows a downtrend in an asset’s price action. The first candle is red (or dark), indicating further losses, followed by a second green candle (or light) indicating increased buyer optimism. This pattern is thought to signal a reversal of a bearish trend.
Bearish Piercing Line Pattern
A bearish piercing line pattern follows an uptrend in an asset’s price action. The first candle is green (or light), indicating continued gains, followed by a second red candle (or dark) indicating shaken buyer confidence. This pattern is thought to signal a reversal of a bullish trend.
How to Identify Piercing Line Pattern in Candlestick Trading?
Like engulfing patterns, piercing line patterns will be located at the end of a prominent downtrend or uptrend in an asset’s price action. Also like engulfing patterns, piercing line patterns will be formed of two candles of opposite colors.
Construction of Piercing Line Pattern
For a bullish piercing line pattern, the first candle in the pattern will be a long, red (or dark) candle. The second candle will be a green (or light) candle that opens lower than the previous close but moves upward throughout the session to close just above the midpoint of the previous day’s candle body. This midpoint is referred to as the piercing line.
For a bearish piercing line pattern, the first candle in the pattern will be a long, green (or light) candle. The second candle will be a red (or dark) candle that opens higher than the previous close but moves lower throughout the session to close just below the midpoint of the previous day’s candle body. Although it is in the opposite direction, this midpoint is likewise referred to as the piercing line.
Key Characteristics of the Piercing Line Pattern
There are several essential characteristics that define a piercing line pattern. It is important for the trader to identify all these characteristics, as they help confirm a true piercing line pattern, which improves the reliability of using this indicator for making trade decisions:
- Prevalent trend – The two candles that comprise a piercing line pattern must come at the end of a noticeable downtrend or uptrend in price movement. A pair of candles that have the shape of a piercing line pattern but follow a heavy succession of price volatility will not perform like a true piercing line pattern.
- Small wicks in the first candle – There will be little to no wicks present on the first candle in the pattern. This shows that price closes near its extreme for the day, continuing with the prevailing trend and likely to continue into the after-hours of trading (for stocks).
- Close/open gap – The opening price of the second candle will be lower (bullish) or higher (bearish) than the close of the previous session, indicating a continuation of the market sentiment in after hours. This is why piercing line patterns are better for stocks, as this gap is not present in 24-hour trading cycles for assets such as crypto or forex.
- Piercing line – The price movement of the second candle retreats to just past the midpoint of the first candle before stopping. This range helps separate a piercing line from an engulfing.
How to Interpret the Piercing Line Pattern?
Piercing line patterns are great tools for indicating that an asset’s price trend has run out of momentum and that a support (bullish) or resistance (bearish) level has been reached. This can help traders predict a reversal in an instrument’s price action.
How to Improve the Reliability of Piercing Line Pattern?
Like all technical analysis tools, it is best to use piercing line patterns as one piece of the puzzle when making trade decisions to improve its reliability.
Having a firm understanding of an asset’s support and resistance levels is critical for maximizing the efficacy of the piercing line pattern. For example, if the piercing line pattern occurs when an asset reaches one of these extremes, it likely indicates a reversal is imminent. Look at the instrument’s 52-week high and low to help get an idea of support and resistance levels.
It is also best to trade piercing line patterns when they confirm a buy or sell signal from divergences in momentum indicators. For example, if the MACD is showing bullish divergence while a bullish piercing line pattern forms, the timing could be ideal for entering a long trade.
How to Trade Piercing Line Pattern in Candlestick Trading?
The efficacy of piercing line patterns is maximized when employing a reversal trading strategy.
Reversal Trading Strategy
A reversal trading strategy involves long traders entering at a low point in an asset’s price movement and capitalizing on gains in an instrument’s price, with short traders selling at a high point in an asset’s price and buying back in after the price drops.
- Market Environment – There must be a strong trend in an asset’s price movement with clear downtrends potentially forecasting bullish piercing line patterns and clear uptrends potential precursors to bearish piercing line patterns.
- Identify and Confirm Trade Opportunity – A trading opportunity is present when an asset approaches a support level (bullish piercing line pattern) or resistance level (bearish piercing line pattern).
- Determine Trade Entry, Stop Loss, and Take Profit Levels – A trade entry point exists when the second candle in the pattern crosses the 50% mark of the first candle’s body. A reasonable stop loss is if the price retreats to the second candle’s opening price. A take profit point could be any point 10% past your entry point, with those traders with higher risk tolerance likely to set this mark higher if they are confident a reversal is truly present.
- Execute and Manage Trade – If the reversal appears to peter out in subsequent candles, it may be a good idea to exit the trade ahead of your take profit, as the second candle in the pattern may have been a short-term correction in an asset’s momentum, with a breakout past a support or resistance level a true threat to cause significant losses.
Advantages and Limitations of Trading Piercing Line Pattern
As with all technical analysis tools, piercing line patterns have noticeable areas of strength and weakness. When trading this pattern, it is important that you account for these pros and cons in your decisions.
Therefore, in the following sections, let us discuss a few main advantages and limitations of trading the piercing line pattern.
Advantages of Trading Piercing Line Pattern
Listed below are the major advantages of trading the piercing line line pattern –
- Very strong indicator of a reversal when all piercing line characteristics have been met
- Easy to identify when trends are present
- Does not involve high-level math or software to calculate
Limitations of Trading Piercing Line Pattern
Listed below are the major limitations of trading the piercing line line pattern –
- Only suitable for stocks, as the gap that is formed after-hours is a fundamental component of the pattern
- Very few true piercing line patterns actually form
- Extremely similar to engulfing patterns, but not as strong
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Conclusion
Bullish/bearish piercing line patterns in candlestick trading are reversal patterns that form at the end of prominent trends in an asset’s price movement.
Formed from two candles, a long first candle will continue the trend of the instrument’s price movement, followed by a gap in which the second candle opens lower (bullish) or high (bearish) than the first candle’s close. A retreat back past 50% of the first candle’s body indicates that a reversal may be imminent with the crossing of this “piercing line.”
Like all technical analysis tools and indicators, piercing line patterns are at their best when used in conjunction with other indicators, specifically when confirming divergences found in momentum oscillators such as MACD.
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