PIERCING PATTERN

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.