An Island Reversal is a piece of price action that is completely broken off from the rest of the chart.
It has a gap before it (Exhaustion Gap) and a gap after it (Breakaway Gap).
A bullish Island Reversal starts with a down gap in a bear trend. After a period of sideways trading, the market gaps upwards to reverse the bearish trend.
A bearish Island Reversal starts with an upwards gap, followed by sideways trading before reversing the trend with a downwards gap.
In both cases, the two gaps must have overlapping price range.
AN ISLAND REVERSAL PATTERN MEAN
The first gap represents a climatic move aligned with the existing trend. However, instead of following through with the gap’s momentum, the market meanders.
Hence, when the market makes a gap against the trend, it is a reversal signal.
The logic behind this chart pattern is similar to the Morning Star and Evening Star candlestick patterns.
TRADE WITH AN ISLAND REVERSAL PATTERN
For a bullish pattern, buy when price gaps up away from the Island.
For a bearish pattern, sell when price gaps down away from the Island.
For this chart pattern, volume should decrease for the first gap and increase with the second gap that is reversing the trend.
For the target objective, measure the height of the Island and project it from the breakaway point.