Thursday 6 September 2012
Bar reversals are good indicators of the probability of counter moves or reversals in the direction of the price movement of a scrip or an index. Bar reversals are often used by technical analysts to understand price movements and predict the future behaviour of the scrip. You are familiar with the concept of
bar charts, explained in Part 2. As explained earlier, bar charts denote the close, high and low prices. These prices may be plotted on a daily, weekly or a monthly basis. The time horizon may vary but the depiction will remain the same. Thus, a daily bar chart will show the high, low and close for a day. A weekly and monthly bar chart will show the high, low and close achieved by the scrip on a weekly or a monthly basis, as the case may be.
Types of bar reversals
There are two types of bar reversals- the upward bar reversal and the downward bar reversal. An upward bar reversal indicates bullish tendencies in the market and may lead to a rise in the price of the scrip or value of the index under consideration. A downward bar reversal indicates a bearish phase and may lead to a fall in the price of the scrip or in the value of the index. Upward and downward bar reversals are further categorized as 'simple' upward or downward bar reversals and 'perfect' upward or downward bar reversals. These bar reversals can be explained by way of the following figure:
The upward and downward bar reversals along with their variants are explained further by way of the following examples:
Upward bar reversal
In case of an upward bar reversal, the low, high and close of the current day are plotted on the chart as against the previous low, high and close. If the low of the current day is lower than the previous low and if the close of the current day is higher than the close of the previous, the phenomenon is known as an upward bar reversal.
In case of a perfect upward bar reversal, the current low is lower than previous low and the current close is higher than the previous close as well as the previous high. This phenomenon signifies significant reversal of trend and may lead to a sharp upswing in the price of the scrip or index and hence needs to be analysed in detail. The upward bar reversal with both the variants (simple and perfect) is exemplified by of the above figure.
Downward bar reversal
In case of a downward bar reversal also, the low, high and close of the current day is plotted on the price chart as against the previous low, high and close. If the high on the current day is higher than the previous high and if the close of the current day is lower than the previous close, the phenomenon is known as downward bar reversal.
In case of a perfect downward bar reversal, the high of the current day is higher than the previous high and the close is lower than the previous close as well as the previous low. This phenomenon signifies a significant reversal in the upward trend and may lead to a sharp downswing in the price of the scrip or index.A perfect downward bar reversal means that the scrip is moving intothe red and needs to be analysed in detail. This also means an opportunity to exit the scrip well in time, to avoid potential losses. The downward bar reversal with both the variants (simple and perfect) is exemplified by of the above figure.
Importance of bar reversals
In the case of an upward bar reversal, the pattern shows that the scrip touches a low which is lower than the previous low. However, at the end of the trading day, due to short covering or the entry of bulls into the fray, the scrip has a close which is higher than the previous close. Thus, the price of the scrip touches a higher close. This indicates buying pressure and the trend may continue in future for smart gains to be made by the scrip or the index, which is the subject matter of study. If the scrip charts indicate that it is oversold, the upward bar reversal becomes more important for the purpose of indicating a possible upswing in the price.
In case of a downward bar reversal, the trend shows that the scrip touches a new high due to increased buying pressure. However, as selling intensified during the close of the trading day, the scrip closes at lower levels than the previous close and logically, this pattern is expected to continue for the next day also. If the downward bar reversal is exhibited during the indicators of an overbought position in a scrip, the reversal is said to have significant strength and can continue to hold its ground. Upward as well as downward bar reversals indicate the potential movement and reaction to price levels based on an analysis of the price pattern seen in the past.
Both these bar reversals are important tools available to technical analysts to give credence to their analysis about the potential upward or downward movement and can be used in conjunction with other tools and theories. No wonder bar reversal patterns offer a great deal of understanding and analysis for those who want to understand why the markets behave the way they do.
