Using the simple 2 bar reversal pattern as a price action trading method to spot potential reversal points, is a nice addition to any trading strategy.
Many traders will confuse the 2 bar pattern with engulfing candlesticks but they aren’t considered to be vastly different. They have the same effect on a trader from a psychological standpoint which makes them both equally useful.
What Is A 2 Bar Reversal Pattern?
This price action pattern comprises 2 large bars or candlesticks each showing a different direction on your chart. We want the first bar to plot strongly in the direction of the current trend direction.
Trending style candlestick (large momentum) plots a strong bullish bar and buyers are feeling good about entering or holding trades.
Hopes for profits are quickly dashed when a bearish bar around the same size of the previous bar, plots right after the previous bar. This has some buyers selling out their position and those looking short, to jump in the move.
I don’t want you to get wrapped up in specific details about the size of the candlesticks or the second candlestick wiping out the previous bar.
- Do you see a strong momentum drive in one direction?
- Was the next print a strong momentum drive in the other direction?
- What was your initial reaction upon seeing the 2 bars print?
Often times, your gut is a great indicator of what the market is doing. Don’t always immediately discount what you are feeling because if you feel it, so do others. The difference is that you will know what to do with the information you have.
That bring us to……
What Are The Best Two Bar Reversals?
When looking for this price action trading pattern, gut feel, as mentioned, is a good barometer of the potential power of the pattern. Psychology is huge in trading and if traders feel their positions are threatened, they will end the trade.
On the flipside, when traders feel a market is showing signs of movement, they don’t want to miss the move and they jump into a trade. There are some things you can look for:
- The pattern stands out on the chart. You don’t have to squint to see it.
- There is obvious intent in both directions and this is especially important for the first bar
- The second bar must take out a “significant portion” of the previous bar. For significant, I look for at least 50% of the previous candlestick
One other attribute that deserves its own mention is where the best 2 bar reversals show up.
I like to see them in trending markets as price comes into potential support and resistance zones. Going back to having the pattern stand out, swing points in the market, as opposed to stuck in the middle of a range, are seen by many.
This market was in rally mode for over a year until it met up against resistance, one which lead to a massive selloff, from 11 years prior.
Price has a break out of resistance at number 1 as if price will continue. Given the little to no upper shadow on the bullish bar, many were looking for further upside.
At number 2, they are thumped to the downside with our 2 bar reversal and a day after that, there was no doubt that ride was over as a massive bear trend bar prints.
This reversal fit our preferred attributes for the reversal bar pattern:
- Strong price action into highs
- Obvious intent to the upside as it breaks resistance
- Candlestick takes out at least 50% of the prior candle
The 2 bar reversal can appear in any market, any time frame, and in any place on the chart. The appearance of the two bar pattern is not always a trade. You need conditions just as I outlined here.
How Do You Trade It?
I mentioned that you can use this pattern in conjunction with your trading strategy. One great use is for traders who just use technical indicators for their strategy. Adding in this price action component could help raise your win rate or at the least, help you manage your trades.
We want to find the reversal pattern at potential support and resistance levels so that is what we look for during a market scan.
Price drove up strongly to resistance and that move will have traders think a continuation will occur. That is one reason waiting for the breakout trade opportunity to pullback or pause, is a better play than entering on the breakout.
We get our bearish bar reversal with a candlestick that took out at least half of the previous bull candlestick.
Where to enter?
I prefer to use a sell stop order below the low of the reversal candlestick as a confirmation of momentum, at least in the short term.
How about a stop loss location?
There is a simple approach and it makes sense to what this pattern is designed to give, a reversal.
Placing your stop loss just over highs is a reasonable location for the stop for when and if your pattern will fail. Don’t hold on waiting for price to come back is an account killer.
What about the reversal at support?
We never know if the reversal is a pure trend change or just a pullback in price. This was an uptrending market and we can use the 2 bar reversal with a bullish bar as a trade entry after a pullback. This is more of an engulfing candle but even with that, it is a two bar reversal.
The double bar reversal is a common pattern but we need to consider trading only at previous turning points, support levels/resistance levels, in the market.
The psychology behind it is obvious: strong momentum in one direction tempts traders to enter. Quick slam back has them running for the exits as their expectations are not met.
It is a bearish pattern in an uptrend and a bullish pattern in a downtrend. You may want to consider a pullback as a reversal and use the 2 bar pattern as an entry.
There is a built in stop loss location at the extreme of the candlestick.
You may want to consider a trade management technique that will allow you to profit from a true trend change.