Piercing Pattern Definition: Day Trading Terminology
A piercing pattern is a reversal signal used in technical analysis to identify a potential shift from a downtrend to an uptrend. The pattern involves a large red bar on the first day and a similar-sized green bar on the next day that initially gaps lower yet closes somewhere around the middle of the last day’s bar.
A piercing pattern is the result of a change in market sentiment as bullish investors manage to bid the price up through a robust day of trading despite continued pressure from bearish investors. Moreover, it is likely that the sudden and pronounced sentiment shift will lead short sellers to book their profits on the recent downtrend, which will further add to upward price pressure in the coming days.
Piercing Pattern Example
Piercing patterns are one of the technical analysis signals that are most often misinterpreted. It is very important that the second day’s bar gaps lower on open, to signal the strong selling pressure, and then reaches well up into the range of the first day’s bar on close, to signal how the strong buying pressure was able to overcome the continued selling pressure.
For example, if the first day closes at $9, the second day opens at $8.50 and then the second day closes at $9.50, this would be a piercing pattern signal. The strong buying pressure has ‘pierced’ back through the strong selling pressure of the previous day and early gap lower, which signals a major shift in market sentiment.
Trading with a Piercing Pattern
The piercing pattern is a trend reversal signal, which means that it indicates a likely subsequent uptrend in the stock price. Most day traders use reversal signals to identify securities that will provide a number of potential trades through trend or momentum investing.
By making trades with the upward trend in a stock, the day trader is able to execute advanced trading strategies reliably based on the reasonable belief that the price of the security will continue to increase over the next few days.
However, there are a number of trading strategies that can make use of piercing patterns or any other reversal signal to execute multiple advantageous trades. Correctly predicting the overall trend of a security’s price is a useful base for making more detailed predictions of upcoming price action.
It is important to remember that the use of the piercing pattern should be supported by complementary technical indicators, analysis of any relevant news and information or fundamental analysis of the security. A piercing pattern alone is not enough to support a trading decision.
Final Thoughts
The piercing pattern reversal signal is another popular technical indicator used primarily in momentum or trend investing. Even for day trading strategies that are not directly related to trend investing, it is still important to be able to predict the general trend of a security’s price action for the next few trading days at least.
However, it is important to remember that the piercing pattern is more prone to false interpretations than most technical analysis signals, and day traders should take care to ensure that the pattern they are observing closely matches the description of a true piercing pattern.