Island Reversal Complete Guide

What is Island Reversal?

The Island Reversal is a short-term trend reversal pattern characterized by a cluster of price action isolated from the preceding and succeeding price movements by two distinct gaps. It begins with an 'exhaustion gap' in the direction of the prevailing trend, followed by a period of sideways or consolidated trading (the 'island'), and concludes with a 'breakaway gap' in the opposite direction. This structure visually isolates the price bars, making them appear like an island on the chart. Technically, the pattern can be either bullish (at a bottom) or bearish (at a top). The gaps must overlap in price range—meaning the price vacuum created by the first gap is mirrored by the second gap at approximately the same level. According to Thomas Bulkowski in the Encyclopedia of Chart Patterns, island reversals are relatively rare and often short-lived. His research indicates that while they are visually striking, their performance can be mediocre compared to major formations. For instance, bearish island reversals in a bull market have a failure rate of approximately 23%, with an average decline of 13%. Volume typically spikes on both gaps, signaling a sudden and violent shift in market sentiment. Steve Nison’s candlestick equivalent, the 'Abandoned Baby,' is a specific, more potent version of this pattern where the island consists of a single Doji. The Island Reversal signals that the previous trend has exhausted its momentum and that a new trend is likely beginning. Traders often look for the second gap to remain unfilled as a sign of pattern validity. If the second gap is closed quickly, the pattern is considered a 'busted' island and may lead to a continuation of the original trend.

Identification Rules

1. The pattern must feature two distinct gaps: an exhaustion gap and a breakaway gap in the opposite direction.
2. The price ranges of the two gaps must overlap, creating a horizontal area of no trading activity.
3. The 'island' cluster must be completely isolated, with no price overlap between the island and the surrounding trend.
4. The island typically consists of 1 to 10 bars; a single-bar island is often more significant (e.g., Abandoned Baby).

References

• Thomas N. Bulkowski (2005). Encyclopedia of Chart Patterns.
• Steve Nison (2001). Japanese Candlestick Charting Techniques.

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