Chart Analysis · Lesson 3 · Beginner

Candlestick patterns and the trend prerequisite

You trade reversal candlestick patterns only in the right trend context and avoid the most common beginner mistake.

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Context beats form

The same hammer candle means something completely different depending on the trend. Morris is clear: a bullish reversal is only valid in a downtrend, a bearish one only in an uptrend. You determine the trend roughly with a 10-period MA (higher highs and lower lows we go deeper into in ct-trend-erkennen, the moving averages in ct-moving-averages).

Hammer in the right context

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The filter

Filtered Candle Patterns (Morris): trade a reversal only when an oscillator is in the presignal area, that is RSI below 20 or above 80. We go deeper into the RSI itself in ct-oszillatoren-kontext, here the rule is enough. This only filters reversals, not continuation patterns.

Test yourself

You see a clean hammer in the middle of an intact uptrend. What do you do?

Ignore it, a bullish reversal only counts in a downtrend
Go long, the hammer is always a buy signal

A hammer appears after a downtrend, and the RSI is at 18. How do you rate it?

Filtered reversal with good context
Weak signal, the RSI just gets in the way

The key points at a glance

A bullish reversal only counts in a downtrend, a bearish one only in an uptrend.
The most common mistake: reading a hammer in the middle of an uptrend as a buy signal.
A pattern is only filtered when an oscillator is also at an extreme.

Deep dive

Buying a hammer in an uptrend: the most expensive beginner mistake

By definition, a reversal needs a prior trend that it reverses. A hammer in the middle of an intact uptrend has no downtrend to turn, and is meaningless no matter how textbook it looks.

A bullish reversal only counts in a downtrend, a bearish one only in an uptrend.
Determine the trend before you look at the candle shape.
During an ongoing trend the candle looks especially tempting.
At the end of the trend the same hammer suddenly carries nothing.

The presignal filter: why a pattern alone is not enough

Morris shows that the hit rate of reversal candles improves markedly when an oscillator sits at an extreme. A reversal needs an overstretched market from which the counter-move draws its strength. A hammer at RSI 50 does not have that starting point.

Only trade a bullish pattern when the RSI is below 20.
Only trade a bearish pattern when the RSI is above 80.
The filter applies only to reversals, not to continuations.
A filtered setup: matching trend, reversal candle at the level, oscillator at an extreme.

Wait for confirmation or enter right away?

A formation is a signal, not a completed reversal. Wait for the close of the next candle, which confirms the direction. That costs you a later entry, but it saves you the many cases where the pretty candle is ignored the next day.

If price rises after the hammer and closes higher, the reversal is running.
Place the stop at half the tail height, not below the tip.
For beginners, the premium of confirmation is almost always right.

Sources: Murphy, Elder, Goodman

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