What it means
Candlestick charts show the open, high, low and close of each trading period as a bar, or candle. A down candle shows that the price closed below where it opened, and an up candle shows the reverse.
The piercing pattern uses two candles, one of each type, appearing at the end of a decline. The first candle is a long down candle that confirms sellers are in charge.
The second candle opens below the first candle's low, showing continued pessimism, but then buyers push the price up to close above the midpoint of the first candle's body. The deeper the second candle closes into the first, the stronger the signal.
The reasoning behind the pattern is psychological. After a drop, sellers expect more weakness, but the sharp recovery shows that buyers are willing to buy at the lower prices.
That change in mood can mark the end of a downtrend, at least for a time. Traders usually look for confirmation before acting.
They may wait for the next day to close higher, check whether trading volume rose on the second candle, or use other indicators such as support levels. A piercing pattern in the middle of a sideways market, or one that is not preceded by a clear decline, carries little weight.
It is a close relative of the bullish engulfing pattern, in which the second candle closes above the first candle's open. The opposite signal, which appears after an advance and suggests a downturn, is the dark cloud cover.
None of these patterns is a guarantee, and tests of their reliability give mixed results. For non-specialists, the useful lesson is that technical patterns describe sentiment rather than predict outcomes.
They can help with timing, but sound decisions should also consider the company's fundamentals and the investor's risk limits. A stop-loss order is commonly used to limit the loss if the pattern fails.
In practice
Real-world examples.
Example
A swing trader sees a share fall for five days, ending with a long red candle. The next day opens lower but closes above the midpoint of that candle, so she buys a small position and places a stop below the new low.
Example
A currency trader notices the pattern on the daily chart of a major pair near a well-known support level. He waits for the following day to close higher before entering, which reduces the chance of acting on a false signal.
Example
A retail investor holding a diversified fund sees the pattern on an index chart. She does not trade on it, but she takes it as a hint to delay selling during a temporary dip.
Formula
Calculation
Midpoint of first candle's body = (open + close) / 2
A piercing pattern requires: the second candle opens below the first candle's low, and closes above the midpoint but below the first candle's open.
Suppose the first candle opens at $50.00 and closes at $44.00, with a low of $43.50. The midpoint of its body is (50 + 44) / 2 = $47.00. The second candle opens at $43.00, below the first low of $43.50, and closes at $48.00. Because $48.00 is above $47.00 and below $50.00, the pattern is confirmed, and the recovery covers (48 - 44) / (50 - 44) = 4 / 6, or about 67%, of the first candle's body.Case study
Seen in the real world.
Thornfield Capital is an illustrative, fictional trading desk that tested a simple rule: buy after a piercing pattern at a support level, with a stop at the pattern's low. Over 100 trades, about half were profitable, but the average winning trade was larger than the average loss.
The head of risk calculated that the average win was $1,800 and the average loss was $1,000. With a 50% hit rate, the expected profit per trade was 0.5 x 1,800 - 0.5 x 1,000 = $400.
She cautioned that the sample was small and that costs would reduce the result, so the desk kept position sizes modest. The illustrative lesson is that a pattern is only one input, and discipline in managing losses is what makes it useful.
Watch out
Common mistakes.
- Treating the pattern as a guaranteed reversal, when it only signals a possible shift in sentiment.
- Using it in a sideways market without a prior decline, where it has little meaning.
- Ignoring position sizing and stop-loss levels, which control the damage when the signal fails.
Questions
People also ask.
What is the difference between a piercing pattern and a bullish engulfing pattern?
In a piercing pattern the second candle closes above the midpoint of the first, while in a bullish engulfing pattern it closes above the first candle's open.
Does volume matter?
Higher volume on the second candle makes the signal more convincing because it shows stronger buying interest.
What is the bearish version called?
It is called a dark cloud cover, and it appears after an advance.
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