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Technicians watch for price clues that can alert them to a shift in market psychology and trend. Reversal patterns are these technical clues.

Yet the term "reversal pattern" is somewhat of a misnomer. Hearing that term may lead you to think of an old trend ending abruptly and then reversing to a new trend. This rarely happens.Trend reversals usually occur slowly, in stages, as the underlying psychology shifts gears.

A trend reversal signal implies that the prior trend is likely to change, but not necessarily reverse. Recognizing the emergence of reversal patterns can be a valuable skill. There are many ways to trade in and out of positions with reversal indicators. An important principle is to place a new position only if that signal is in the direction of the major trend.

The Doji Pattern

A Doji is usually a relatively short candlestick with no real body, or very little real body. It indicates that the opening and closing prices for the period were at the exact same level or very close together. In terms of market psychology, a Doji indicates that there is indecision and uncertainty in the market with neither buyers nor sellers able, or willing, to move the price to significant levels, which would indicate a weakness in the current trend and a possible reversal.

Types of Doji

Depending on where the open/close line falls, a Doji can be described as a gravestone, long-legged, dragonfly, and four-price Doji as well.

Long-Legged Doji

The long-legged Doji is a candlestick that consists of long upper and lower shadows and has approximately the same opening and closing price. It shows there was a battle between the buyers and sellers but ultimately they ended up about even. And it is the very reason why it signals indecision about the future direction of market trend.

Since the pattern is viewed as an indecision period, a trader could wait for the price to move above the high or low of the long-legged Doji. If the price moves above, enter a long position. If the price moves below the pattern, enter a short position. Additionally, if entering long as the price moves above the long-legged Doji or consolidation, place a stop loss below the pattern or consolidation. If entering short as the price moves below the long-legged Doji or consolidation, place a stop loss above the pattern or consolidation.