Key Reversal Bar After Uptrend
A key reversal at the top of an uptrend occurs when prices are making higher highs and higher lows (thus the definition of an uptrend) followed by another bar who's high price is higher than the previous day's high (usually the open is above the previous day's high as well) and who's low and close is below the previous day's low. The psychology of the pattern acts as follows: an uptrend is in effect, prices open higher and make yet another new high (so far buyers are in control), yet by the end of the day prices fall below the low of the previous day. Buyers were unable to keep prices at higher highs and were unable to defend keeping prices above the previous day's low. The lower low established by the key reversal is a strong warning of potential trend change.
Key Reversal Bar After Downtrend
A key reversal at the bottom of a downtrend occurs when prices are making lower highs and lower lows (thus the definition of a downtrend) followed by another bar who's low price is lower than the previous day's low (usually the open is below the previous day's low as well) and who's high and close is above the previous day's high. The beginning of the key reversal day looked like a continuation of the downtrend (i.e. lower lows) yet by the end of the trading day prices made a higher high, warning of a possible trend change.
Note that if prices exceed the high of the key reversal price bar (for a key reversal top) or the low of the key reversal (for a key reversal bottom) then the pattern is invalidated (Kirkpatrick & Dahlquist, 2010, p. 373). Rockefeller (2011) suggests a sell signal when prices break below the low established by the key reversal top, if it occurs within the next two or three days (p. 121).
Key Reversal Bar After Uptrend Chart Example
The chart above of the S&P 500 ETF (SPY) shows a key reversal bar at the top of an uptrend. There is a strong price channel upward, then the key reversal bar gaps up and opens higher than the prior day's high, making a new higher high. However, sentiments change within the trading day and prices close at the low of the prior day's low and create what will be the beginning of more lower lows to come.
Key Reversal Bar After Downtrend Chart Example
The Dow Jones Industrial Average ETF (DIA) shows a key reversal bottom pattern after a month long downtrend. Prices open lower than the prior day's close and proceed to make lower lows. Thus far it seems as if the downtrend will be continuing. Nevertheless, buyers come in and are able to close prices above the prior day's high creating a higher high in the process. Prices then gap up the next day, create two price bars with higher highs and then gap up yet again.
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