Piercing Pattern: Definition, Formation, and Strategies

Piercing Pattern: Definition, Formation, and Strategies
Piercing Pattern

As India’s growth story has picked up pace, people are experimenting with investments that were not conventionally followed in this part of the world. Just a couple of decades ago, stock markets were a thing of the elite. But over the years, the masses have broken through the shackles and started investing in the Indian stock markets.

While equity investments provide good returns and liquidity, they involve high risk. However, there are tools like fundamental & technical analysis used by investors to minimize risk in the stock markets. One such technical analysis tool is “Piercing Pattern”. Keep reading to learn how you can use this tool to your advantage!

What Is a Piercing Pattern?

What Is a Piercing Pattern

As the name suggests, a piercing line pattern refers to a candlestick formation that shows the effect of piercing through an ongoing trend to reverse it. It can be both bullish & bearish depending on the preceding trend.

Bullish Piercing Pattern

Bullish Piercing Pattern

So, here’s the definition of a bullish piercing pattern:

In an ongoing bearish trend, 2 consecutive candles are formed such that:

  • The first candle is bearish
  • The second candle is bullish and shows the following:
    • A Gap down opening from the close of the first candle, and
    • The price closes above the midpoint of the bearish candle, i.e. above 50%

The following image represents a bullish piercing pattern.

*Red Candle: A bearish candle with a lower closing price than the opening price.

**Green Candle: A bullish candle with a higher closing price than the opening price.

Bearish Piercing Pattern (Dark Cloud Cover)

Bearish Piercing Pattern

It is the polar opposite of the bullish pattern. So, here’s the definition of a bearish piercing line pattern:

In an ongoing bullish trend, 2 consecutive candles are formed such that:

  • The first candle is bullish
  • The second candle is bearish and shows the following:
    • A Gap up opening from the close of the first candle, and
    • The price closes below the midpoint of the bullish candle, i.e. below 50%

The following image represents a bearish piercing line pattern.

Also Read: Tweezer Bottom Pattern

Understanding Piercing Pattern

When we discuss the piercing line pattern, whether it is bearish or bullish, it is more important for traders to interpret it correctly to unlock the pandora’s box. Here’s a comparison to know the difference:

PointersPiercing Pattern (Bullish)Piercing Pattern (Bearish)
Type of PatternBearish Reversal / BullishBullish Reversal / Bearish
AkaBullish Piercing Line PatternBearish Piercing Line Pattern / Dark Cloud Cover
Preceding TrendBearish TrendBullish Trend
Formation Candle 1Bearish CandleBullish Candle
Formation Candle 2Bullish Candle:

Gap Down Opening
Closes above 50% of Candle 1
Bearish Candle:

Gap up Opening
Closes below 50% of Candle 1
ConfirmationIndicators that confirm the pattern:

Increased Volume
The pattern occurs near Moving Averages
The pattern occurs near important Support Level
RSI indicates Oversold
The 3rd candle opens with a gap up and is bullish
External factors
Indicators that confirm the pattern:

Increased Volume
The pattern occurs near Moving Averages
The pattern occurs near important Resistance Level
RSI indicates Overbought
The 3rd candle opened with a gap down and is bearish
External Factors

How Does a Piercing Pattern Work?

How Does a Piercing Pattern Work

Now that you have learned how to identify the piercing pattern, the next step is to understand where you can enter the trade and what is the expected return on investment. Here’s how traders interpret the piercing price pattern to make profitable trades:

PointersBullish Piercing PatternBearish Piercing Pattern
Type of TradeBuy for rise in priceSell / Short Sell for a fall in price
Steps to IdentifyIdentify the Pattern
Confirm the Pattern
Identify the Pattern
Confirm the Pattern
Entry PointAt the opening of the third candle
After prices retrace a bit
At the opening of the third candle
After prices recover a bit
Stop LossJust below the lower wick of the bullish candleJust above the highest price of the bearish candle
Target PriceCan be decided based on:

Difference between 1st Candle high & 2nd candle low
Resistance Levels
Historical Price Data
Trendlines
Comparative fundamental ratios of industry & the stock
Fibonacci Retracement Recent Swing highs and lows
50-200 days moving average
Formation of a bearish pattern
Trailing stop loss when you are unsure of the target
Can be decided based on:

Difference between 2nd candle high & 1st candle low
Support Levels
Historical Price Data
Trendlines
Comparative fundamental ratios of industry & the stock
Fibonacci Retracement 
Recent Swing highs and lows
50-200 days moving average
Formation of a bullish pattern
Trailing stop loss when you are unsure of the target

Example: Piercing Line Pattern

Example Piercing Line Pattern

Let’s see a practical example of the Bullish Piercing Pattern in the Nifty 50 chart.

Identification FactorsExplanation
Preceding TrendA downtrend followed by a strong support zone just below the bearish candle
Candle 1Bearish Candle was formed on 14th October 2022
Closing Price: Rs. 17,185.70
Candle 2Bullish Candle was formed on 17th October 2022
Gap Down Opening: Rs. 17,144.80
Closing Price: Rs. 17,311.80 (>50% of Candle 1)
ConfirmationNifty had struck a strong support just before the piercing-pattern
In the Support Zone, the chart shows the formation of a Tweezer Bottom Pattern with volumes more than 1.8 times
Entry PointOpening of Candle 3 on 18th October 2022 at Rs. 17,438.75
Stop LossBelow the Lower Price of Candle 2: Rs. 17,050
Target met on 1st DecemberAs per the previous Swing Rs. 18,500
With Trailing Stop Loss: Rs. 18,800
Profit within 43 daysMinimum: 6.09% (equivalent to 51.69% p.a.) 
Maximum: 7.81% (equivalent to 66.29% p.a.)

The following image shows the chart of Nifty in the discussed time frame:

example piercing chart Nifty

We use the trailing stop loss method when the target price is uncertain. As the price of a stock goes up, we place a stop-loss order below the previous closing price.

Is the piercing pattern bullish or bearish?

Is the piercing pattern bullish or bearish

Piercing patterns can be both bullish or bearish, depending on the direction of the preceding trend. Here are the key characteristics of both the patterns:

  • Bullish Piercing Pattern 
    • The market is in a downtrend with consecutive bearish candlesticks
    • The price can be close to an important support level
    • 2 consecutive candlesticks are formed:
      • 1st Candle: A large bearish candlestick 
      • 2nd Candle: A bullish candlestick that opens below the previous day’s low and closes above the midpoint of the prior day’s candle
    • This suggests:
      • a potential reversal of the downtrend 
      • buying pressure has overwhelmed the selling pressure
  • Bearish Piercing Pattern
    • The market is in an uptrend with consecutive bullish candlesticks
    • The price can be near an important resistance level
    • 2 consecutive candlesticks are formed: 
      • 1st Candle: A large bullish candlestick 
      • 2nd Candle: A bearish candlestick that opens above the previous day’s high and closes below the midpoint of the prior day’s candle. 
    • This suggests:
      • a potential reversal of the uptrend
      • selling pressure has overwhelmed the buying pressure

In a nutshell

  • The piercing patterns shows trend reversal
  • It can be both bullish or bearish
  • To confirm the pattern you should check other factors like,
    • Preceding Trend
    • Support/Resistance Levels
    • Volumes
    • RSI overbought/oversold
    • External Factors
    • Fundamental Analysis
  • You can set the targets in many ways as discussed in this blog
  • Monitor the price fluctuations closely
  • Always keep a trailing stop loss as a safety net

If you follow all the steps discussed in this blog, you will be able to profit from the piercing patterns whenever you see it in a stock’s chart!

FAQs

What is the Piercing Pattern in trading?

The Piercing Pattern is a trend reversal candlestick pattern in technical analysis. Depending on the preceding trend, it can be both a bullish or a bearish piercing-pattern.

How is the Piercing Pattern formed on a price chart?

The Piercing-Pattern forms on a price chart when a downtrend is potentially reversing. It comprises a large bearish candle followed by a bullish candle that opens below the previous day’s low but closes above the midpoint of the prior day’s candle, indicating a shift in market sentiment.

Can you explain the significance of the Piercing Pattern in technical analysis?

Traders use a piercing-pattern as a key technical indicator as it signals potential trend reversals. It provides the traders with entry & exit points that can be followed to profit from the pattern.

What are the key characteristics of a Piercing Pattern?

The key characteristics of a Piercing Pattern include two candlesticks:
A large bearish candle followed by a bullish candle
The bullish candle opens below the prior day’s low but closes above the midpoint of the bearish candle

How does the Piercing Pattern signal a potential reversal in market trends?

The bullish candle opens lower and closes above the midpoint of the prior day’s bearish candle. This suggests that buying pressure is overcoming selling pressure, indicating a shift from a downtrend to a possible uptrend.

Are there variations or types of Piercing Patterns?

Yes, variations of the Piercing Pattern include:
Bullish Piercing Pattern
Bearish Piercing Pattern

In what market conditions is the Piercing Pattern commonly observed?

The Piercing Pattern is commonly observed in markets experiencing strong trends, whether bullish or bearish. It often appears at:
key support or resistance levels
during periods of heightened volatility & volumes 
significant price movements

What strategies do traders commonly use when recognizing a Piercing Pattern?

Here are some key strategies that traders commonly use when recognizing a Piercing Pattern
Confirmation signals from other indicators
Increased trading volume
Support and resistance levels
RSI trends
Overall market sentiment
Stock Fundamentals
Risk Management techniques like a trailing stop loss

Are there specific volume considerations when trading based on the Piercing Pattern?

Yes. Volumes indicate stronger patterns and validate a reversal signal. If the volumes during the piercing pattern or at critical support levels are high, traders become more willing to ride the wave.

What risks should traders be aware of when incorporating the Piercing Pattern into their analysis?

There are many risks associated with Piercing Patterns that traders should be aware of:
False signals that show more indecision than a pattern
Relying solely on the Piercing Pattern without considering other technical indicators
Investing in a company with poor fundamentals
Not using proper risk management tools

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