PIERCING PATTERN
During many of my speaking
engagements, after I have discussed the bearish dark-cloud cover pattern, it's
not too long before I am asked if there is an opposite formation. Yes, there is
and it is called a piercing pattern. Just as a dark-cloud cover is a top
reversal, its opposite, the piercing pattern, is a bottom reversal (see Exhibit
4.29). It is composed of two candlesticks in a falling market. The first
candlestick is a black real body day and the second is a long, white real body
day. This white day opens sharply lower, under the low of the prior black day. Then
prices push higher, creating a relatively long, white real body that closes
above the mid-point of the prior day's black real body.
The bullish piercing pattern is
akin to the bullish engulfing pattern. In the bullish engulfing pattern the
white real body engulfs the previous black real body. With the bullish piercing
pattern, the white real body only pierces the prior black body. In the piercing
pattern, the greater the degree of penetration into the black real body, the
more likely it will be a bottom reversal. An ideal piercing pattern will have a
white real body that pushes more than halfway into the prior session's black
real body. If the market closes under the lows of the bullish engulfing pattern
or the piercing pattern by way of a long black candlestick, then another downleg
should resume.
The psychology behind the
piercing pattern is as follows: The market is in a downtrend. The bearish black
real body reinforces this view. The next day the market opens lower via a gap. The
bears are watching the market with contentment. Then the market surges toward
the close, managing not only to close unchanged from the prior day's close, but
sharply above that level. The bears will be second guessing their position. Those
who are looking to buy would say new lows could not hold and perhaps it is time
to step in from the long side.
The piercing pattern signal
increases in importance based on the same factors (1) through (4) as with the
dark-cloud cover, but in reverse. (See previous section.) In the section on the
dark-cloud cover, I mentioned that although some Japanese traders like to see
the black real body close more that midway in the prior white candlestick, there
is some flexibility to this rule. With the piercing pattern, there is less
flexibility. The piercing pattern's white candlestick should push more than halfway
into the black candlestick's real body. The reason for less latitude with the
bullish piercing pattern than with the bearish dark-cloud cover pattern is the
fact that the Japanese have three other patterns called the on-neck, the in-neck,
and the thrusting pattern (see Exhibits 4.30 to 4.32) that have the same basic
formation as the piercing pattern, but which are viewed as bearish signals
since the white real body gets less than halfway into the black's real body.
Thus these three potentially
bearish patterns (Exhibits 4.30 to 4.32) and the bullish piercing pattern (Exhibit
4.29) all have the same form. The difference between them is in the degree of
penetration by the white candlestick into the black candlestick's real body. The
on-neck pattern's white candlestick (usually a small one) closes near the low
of the previous session. The in-neck pattern's white candlestick closes
slightly into the prior real body (it should also be a small white candlestick).
The thrusting pattern should be a longer white candlestick that is stronger than
the in-neck pattern but still does not close above the middle of the prior
black real body.
With these patterns, as prices
move under the white candlestick's low, the trader knows that it's time to sell.
(Note that the thrusting pattern in Exhibit 4.32 is bearish in a declining
market, but as part of a rising market, would be considered bullish. The
thrusting pattern is also bullish if it occurs twice within several days of
each other.)
It is not important to remember
the individual patterns in Exhibits 4.30 to 4.32. Just remember the concept
that the white candlestick should push more than halfway into the black
candlestick's real body to send a bottom reversal signal.
In Exhibit 4.33, the bears
successfully knocked the market to new lows for the move on April 27 as shown
by the long black day. The next day the market opened lower. This opening
turned out to be the low of the day and Boeing closed well within the prior day's
black real body. The two candlesticks on April 27 and 28 created the bullish
piercing pattern.
Exhibit 4.34 shows a classic
piercing pattern during the week of March 26. Note how the white real body
followed a very weak long, black real body. The white day opened on a new low
for the move. The strong close that day, which pushed well into the previous
black real body, was a powerful indication that the bears lost control of the
market. The white day was a very strong session. It opened on its low (that is,
a shaven bottom) and closed its high (that is, a shaven head). Note how this
bullish piercing pattern brought to an end the selloff that commenced with the
bearish engulfing pattern of March 19 and 20.
On this Wheat chart there is also
a variation of the piercing pattern during the week of March 12. The reason it
is a variation is because the white real body opened under the prior day's real
body, but not under the prior day's low. Nonetheless, because the white real
body closed more than 50% into the prior day's black real body it was a warning
sign that the prior downleg was
running out of steam.
Exhibit 4.35 illustrates how
candlestick patterns can help the analyst get a quick sense of the market's
health. During the latter part of February 1990, a broker asked me what I
thought of oats. I rarely monitor oats. Nonetheless, I retrieved the candlestick
chart shown in Exhibit 4.35 and told him that the downtrend was probably over. Why?
I had noticed that during the week of February 20, an almost classic piercing
pattern appeared. I also saw this piercing pattern coincided with a successful
test of the early February lows. This increased the chance that a double bottom
had been built.
Exhibit 4.36 illustrates that the
downtrend, which began with the bearish engulfing pattern in late 1984, ended
in mid-1987 with the appearance of this piercing pattern. Although the market
did not rally after this bottom reversal signal, the signal did forecast the
end of the selling pressure that had pulled the market down from mid-1984 to
mid-1987. After the piercing pattern the market stabilized for a year, and then
rallied.