Identifying a reversal in a Forex market is normally very crucial. It determines the amount of profit that the trader makes. If a trader, for instance, has a running long position, he/she will have to be very careful to identify any trend reversal. The earlier he/she identifies the reversal, the earlier he/she will close the trade and thus locking on to more profits. If there is a delay in closing the trade, then the trend reversal will eat into the profits made during the bullish trend.
Candlestick patterns like island reversal pattern are very helpful in identifying reversals in the market.
The beauty of it is that candlestick patterns are very easy to identify. The trader can identify them without the need to use any technical indicator. It only requires the use of the eyes and an understanding of what a specific pattern means and how to trade after identifying it.
Identifying the island reversal pattern
The most recognizable features of the island reversal pattern are a market gap and the formation of a doji candlestick. And in most cases, the market gap will form prior to and after the formation of the doji or any other type of reversal candlestick.
The term island was obtained from the fact that the reversal candlestick, like the doji, is left alone in a type of an island after the two market gaps prior and after its formation.
It is not a must that the reversal candlestick is a doji. It could be another reversal candlestick, like the hammer, or an even reversal pattern, like the morning star or the evening star. The only important thing is that there has to be a market gap before and after the reversal candlestick or reversal pattern.
There are quite a number of market gaps and traders must learn not to confuse the specific one that makes up the island reversal pattern. Some gaps are normally a sign that the market trend is preparing to continue.
The gap after the reversal candlestick has formed is in the opposite direction to the prior gap and in the opposite direction to the previous market trend.
Depending on the type of reversal, an island reversal pattern can be characterized as bullish or bearish.
Bullish island reversal
It forms when there is a bearish trend. A market gap takes place pushing the market prices further lower but after which a reversal candlestick or pattern, like a doji, forms indicating that the buying pressure is gaining momentum and the market is preparing to reverse. Then there is another market gap but in the opposite direction pushing the market prices upwards. Immediately after the second gap, a bullish candlestick is formed confirming that the trend has reversed from a bearish trend to a bullish trend and thus the name bullish island reversal.
The reversal candlestick that is formed after the market gapping downwards could be any other bullish reversal candlestick apart from the doji. For instance, it could be a hammer. It could also be a bullish reversal candlestick pattern (a combination of candlestick) like the morning star candlestick pattern.
Bearish island reversal
It forms when there is a bullish trend. A market gap takes place pushing the market prices further up but after which a reversal candlestick or pattern, like the doji, forms indicating that the selling pressure is gaining momentum and the market is preparing to reverse. Then there is another market gap but in the opposite direction pushing the market prices downwards. Immediately after the second gap, a bearish candlestick is formed confirming that the trend has reversed from a bullish trend to a bearish trend and thus the name bearish island reversal.
The reversal candlestick that is formed after the market gapping upwards could be any other bearish reversal candlestick apart from the doji. For instance, it could be a Bearish Abandoned Baby Engulfing, Bearish Harami, Bearish Dark Cloud Cover, Evening Star or the Shooting Star candlestick patterns.
Placing trades after identifying the island reversal patterns
- Entry point: For the bullish island reversal pattern, the trader should place a buy order after the bullish candlestick that forms after the bullish market gap that forms after the doji or any other bullish reversal candlestick for that matter. On the other hand, for the bearish island reversal pattern, the trader should place a sell order after the bearish candlestick that forms after the bearsih market gap that forms after the doji or any other bearish reversal candlestick for that matter.
- Exit point: the best way of exiting a trade placed after identifying the island reversal pattern is by using the stop levels (the stop loss and the take profit levels). This is because you would like to take advantage of the thrust of the market movement immediately the reversal happens and get out earliest possible.