When trading price action-based using technical analysis, you may have encountered a chart pattern during the price action’s consolidation phase. Some chart patterns can help highlight potential continuations or reversals, but they’re not always easy to spot, and their impact varies by context. In the article below, we will be exploring one such chart pattern in detail.
In this article, we will understand the Bullish Island Reversal chart pattern, its structure, how to identify it, how to trade it with an example, its advantages, and disadvantages.
What is the Bullish Island Reversal chart pattern?
The Bullish Island Reversal is a relatively rare pattern formed when the price is “isolated” by gaps on both sides, often signalling a potential shift from bearish to bullish sentiment.
The pattern shows a gap down before it forms and followed by a gap-up opening after the pattern formation.
The term “island” refers to the price action; the pattern suggests a temporary pause in a downtrend, followed by a strong buying interest creating a gap-up opening, signalling a potential bullish reversal.
Structure
- Gap Down: The security is trading in a downtrend, the price opens lower than the previous day’s close, leaving a blank space or “gap” on the chart called gap-down opening, indicating the seller’s strength.
- Island Formation: The price consolidates within a narrow range on low volume, showing indecision and a lack of clear trend direction.
- Gap Up and Reversal Signal: The following candle opens higher than the previous day’s close, leaving a blank space or “gap” on the chart, which is called gap-up opening, and the gap-up between the candles indicates buyer strength and confirms the bullish reversal.
How to Identify a Bullish Island Reversal Pattern?
Identify a security trading in a downtrend and with a gap-down opening from the previous day’s close. Wait for the candle to trade within a small price range.
After the consolidation, spot a gap-up opening immediately after the previous day’s close, followed by confirming that volume spikes indicate strong participation. Wait for the confirmation as the follow-through buying and higher closes after the gap up.
How to trade the Bullish Island Reversal chart pattern?
Buy Signal:
Entry:
- Enter a long position trade as the candle closes above the gap-up level, confirming the breakout from the island.
Stop-loss:
- Place the stop loss at the low of the consolidation range and trade with smaller quantities initially, and later add on.
Target:
- Place the target by measuring the height of the island and adding that height to the breakout level.
Target Price = Gap-Up Breakout Level + Height of the Island
- Or set your target using your preferred risk-reward ratio, such as 1:1, 1:2, or higher.
Example:
The chart below shows an example of “HCL Technologies Ltd” stock at a 1-day timeframe from 21st July to 10th August 2023. As you can see, the buy signal was generated by the Bullish Island Reversal chart pattern.
What are the advantages of the Bullish Island Reversal chart pattern?
- The Bullish Island Reversal pattern provides a clear understanding of the price action and indicates clear entry, stop-loss, and target for everyone.
- The Bullish Island Reversal is versatile across all timeframes and all other security markets, as a single strategy, can be applicable for all markets.
- The Bullish Island Reversal pattern acts as a strong support level after the breakout of the pattern.
- While trading the Bullish Island Reversal pattern, the island height helps in calculating target levels after a breakout.
The disadvantages of the Bullish Island Reversal chart pattern:
- False breakouts can occur in a Bullish Island Reversal when, after the gap-up, the price retraces briefly on low volume before quickly reversing again, especially in low-volume or sideways market conditions.
- By the time the Bullish Island Reversal confirms, much of the move may have already happened.
- The Bullish Island Reversal often takes a long time to develop, especially on higher timeframes.
In Closing
In this article, we learned the Bullish Island Reversal chart pattern, its structure, how to identify it, how to trade it, along with an example, its advantages, and disadvantages.
The Bullish Island Reversal chart pattern is a powerful tool that signals potential reversals in the ongoing downtrend, indicating multiple opportunities for clear entry and exit signals.
Your profitability depends on your approach to the trade, your risk management, and your mindset when you are holding the trade, as no indicator or tool is 100% accurate, and as the Bullish Island Reversal chart pattern’s efficiency and accuracy increase rapidly when it is combined with additional indicators or tools (RSI, MACD, or others).
