Compare the variety of ways to spot necklines.

Another trend confirmation candlestick pattern is the neck line, which comes in several varieties.

The bullish neck line forms over two candles during an uptrend:

•    First is a long ascending (white or clear) candlestick that indicates a lot of buying pressure; and
•    Next is a descending (red or black) candle, which may be either long or short. There’s a gap up on opening and the stock may trade briefly higher, but the price then falls back to or slightly below the previous day’s close. However, the bears cannot force the price any lower than that, indicating the presence of continued strong buying pressure.

The bearish neck line forms over two candles during a downtrend:
•    The first candle is a long descending one that illustrates a lot of selling pressure; and
•    The second one is an ascending candle which may be long or short. The price gaps down on opening and the price may fall somewhat lower, forming a lower wick. Buying pressure then emerges and the bulls drive the price higher. However, sufficient selling pressure remains that they cannot force the price above or much above the previous day’s close.

If the second day’s close is at or near that of the preceding candle, then the pattern is called the bullish or bearish on neck line. But if the second day’s close is a little lower, falling within the real body of the first, ascending candle, then the pattern is called the bullish or bearish in neck line. The two are very similar in appearance and trade identically, so the difference is of interest only to the purist.

Below is a partial chart of Eastern Star Gas (ESG) for earlier this year:

A long descending candle forms in early May, showing the presence of significant selling pressure as well as a major volume spike. The price gaps lower on the next day’s opening and trades briefly down. Then bulls enter the market and force the price higher again.

But although the upper wick shows the bulls’ efforts, they proved unable to drive the price much higher and were forced to settle for a close equivalent to the preceding day’s level, forming a descending on neck line pattern. The price retraces 50% of its descent over the next few days and then the downtrend resumes, with the spike in late May to 0.615 forming the 52-week low.

When trading a neck line pattern, the important technical level is the opening price of the first trading day. If the price in succeeding days is able to reverse beyond that level, then traders should consider the trading signal as failed or invalid. On the example chart above, note how the retracement isn’t able to overwhelm the first candle’s opening price, although it likely gave the stock’s candlestick traders a few unhappy days before the downtrend resumed.