Two Warning Patterns to Watch

I’m beginning to see ominous signs of trouble brewing for homebuilders. It’s good timing too – as we’re shining a laser-focused light on this sector’s biggest problems in our upcoming April issue of Boom & Bust.

For today, let’s stick to a couple of candlestick chart patterns I’ve just identified.

(As far as candlestick patterns go, get used to some pretty funny names.)

First up is the “bearish engulfing candle.” As a bearish signal, the naming of this pattern is apropos… it fully “engulfs” the preceding candle.

Imagine you’re a bullish investor during an uptrend. Here are two questions for you:

1) You’ll be more confident in your bullish bias if you see today’s highs breaking above yesterday’s highs, right? (Hint: your answer should be yes).
2) Likewise, you’ll be LESS confident in your bullish bias if you see today’s lows breaking below yesterday’s lows, right? (hint: say “yes”)

But what happens when BOTH of these events happen… on the same day?

Well, that’s how investors get caught on the wrong side of a trade. Late momentum buyers buy as prices make new highs. And on bearish engulfing days they lose a lot of money. They often sell out quickly, or have their stop losses hit, which only adds fuel to the selloff.

This one pattern – the bearish engulfing candle – is often an excellent clue that a market top is forming.

Look at this chart of the SPDR S&P Homebuilders ETF (NYSE: XHB):

See larger image

See that bearish engulfing candle I circled in the top right corner of this chart? That’s an important signal, particularly because XHB acts as a proxy for all homebuilders.

But it is good to see confirmations, so I’ve been sifting through individual homebuilder stocks as well. And I found what I was looking for…

Here’s another bearish pattern, this time in NVR Inc. (NYSE: NVR). This one is called an “evening star.” It’s made up of three candlesticks (days) in a specific pattern:

1) A big “up day” (long, green candlestick), followed by
2) A gap up on Day 2, with a very small trading range for the day, followed by
3) A gap down on Day 3, with a big “down day” (long, red candlestick)

Here’s this pattern shown in NVR…

See larger image

I don’t use candlestick patterns for automated buy/sell signals… but these are excellent warning signals that a trend change may be in the works.

Buyers beware!

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Categories: Markets

About Author

Adam O'Dell has one purpose in mind: to find and bring to subscribers investment opportunities that return the maximum profit with the minimum risk. Adam has worked as a Prop Trader for a spot Forex firm. While there, he learned the fundamentals of trading in the world’s largest market. He excelled at trading the volatile currency markets by seeking out low-risk entry points for trades with high profit potential. An MBA graduate and Affiliate Member of the Market Technicians Association, Adam is a lifelong student of the markets. He is editor of our hugely successful trading service, Cycle 9 Alert.