Today we analyze the Key Reversal Candlestick Pattern. You will learn how to create and use this indicator in your automatic trading systems. We start with the simple High and Low Bar Reversal.
The Reversal Bearish Bar occurs when:
Today Price High > Yesterday Price High
Today Price Close < Yesterday Price Close
The Reversal Bullish Bar occurs when:
Today Price Low < Yesterday Price Low
Today Price Close > Yesterday Price Close
This pattern alone is not very significant because you can see it appears frequently. Anyway, we create a little trading system to test these signals.
The Trading System opens a short and long position. We stay in a position for X days without a stop-loss. We stay in a position for X days. Time frame: Daily – SPY ETF for this test.
The results show the inconsistency of this strategy. As we can see, only the long side has an acceptable percent of profitable trades. This means that the price reverses only after a bullish pattern, but not strongly enough. In fact, the average net profit is too small.
So this pattern is not significant even when considered alone. The price doesn’t react fast after. Let’s go to analyze the more specific pattern.
Key Reversal Bar
The Key Reversal Bearish Bar occurs when:
Today Price Open > Yesterday Price Close
Today Price High >Yesterday Price High
Today Price Close < Yesterday Price Low
The Key Reversal Bullish Bar occurs when:
Today Price Open < Yesterday Price Close
Today Price Low >Yesterday Price Low
Today Price Close > Yesterday Price High
The key reversal bars open with a price gap. So, this pattern is only for daily charts because in an intraday chart is very difficult to find a gap.
When you see this pattern, you know that there is a change in the market sentiment. You can see the strength of the price movement that anticipates a change in direction.
Many times this pattern is like Pin Bar and Outside Day Bar. In this chart, there are two consecutive patterns: Outside Day and Key Reversal at the same time.
If we create another trading system to test this pattern, we can discover that the short side doesn’t work. The long side is profitable, but the number of total trades is too low, and it is difficult to insert some filters.
Why did we hold the position for only 5 days? Because we would like to understand if the price reacts fast after the pattern.
If you want to use this pattern as a filter, you need to know how fast the price reacts.
If we hold the position for many days, we can see that the results became better.
We can also try a volume filter for educational purposes.
The Key Reversal Pattern generally shows a violent price movement. The price could change direction if institutional traders open large positions. If this is true, you will also observe an increase in volumes.
To add this filter, you have to create a Volume Moving Average.
MA_Volume = Average(Volume, 20);
When the daily Volume is bigger than his 20 periods moving average, the pattern is valid.
The Key Reversal Pattern could work as a filter, but it occurs too rarely.
We test the long side of this system with 18 U.S. major stocks over a 20 year period, $10,000 for every trade with no stoploss with a 5 days schedule to exit the trade.
This is the video with the trading system results in TradeStation:
We observe many good results so that this pattern could be a valid filter for many instruments.
If you use the key reversal as a filter, remember that the overall number of trades will decrease because this pattern is infrequent.
It’s also important to consider the trend; the reversal is only noise in a range-bound market.
Also, support and resistance are important because, near this area, the pattern is stronger.
As a discretionary trader, you could create a market scanner for a large portfolio of Stocks.
This is the Code of the Indicator and the Strategy:
TRADERPEDIA: Key Reversal Pattern