In chart formations, an On Neck Pattern is a grouping of two candlesticks on consecutive trading periods which serve to signal a bearish continuation of what is likely a sustained downtrend. The first day of the pattern manifests a candlestick with a long black body. The second day displays a white candlestick which closes at the same price level as the black candlestick’s low.

As previously mentioned, the On Neck formation is classified as a bearish continuation pattern which appears in a down market. Because of this, it is often used to identify when a stock is poised to continue dropping in price for the foreseeable future. Its status as a bearish continuation indicator is not strong, however. According to Thomas Bulkowski, the On Neck extends the existing bearish price trend no more than 58 percent of the time in a bear market. This is only slightly better than the pattern’s performance in an upward trending market, which is 56 percent.

This means that the On Neck can signify a reversal or imminent ranging only slightly less than it can be used to forecast continuations in either market. Despite this randomness, however, the pattern is very strong. Once it shows up, the likelihood is great that the stock will continue its current downward plummet for a while to come.

The psychology behind the On Neck pattern is similar to that of its cousin, the In Neck. Bears have the market in a chokehold and are succeeding at establishing consistent new lows. Nothing about this seems to change on the first day of the In Neck pattern, but the second day might give some traders hope of soon going long.

The fact, however, that the bulls were not able to keep their momentum going long or hard enough to break past the previous day’s low appears to demoralise buyers. In other words, despite the bulls winning a battle, it appears the bears are still winning the war. Buyers will then begin to unload their stock and either change position or await a more favourable time to go long in the market.

As with most bearish continuation patterns, confirmation for the On Neck manifests on the third day as a black candlestick, a gap down or a lower close.

The hallmarks of an On Neck pattern are summarised below:

 

• The market will be in an uptrend, although this is not required.
• Day one will have a long black candlestick followed by a white candlestick on day two.
• The white candlestick will gap down on the open while closing at or very near the previous day’s low.
• On Neck formations are almost as likely to lead into a reversal as they are a continuation.
• Confirmation will be a black candlestick, a gap down, or a lower close on the third day.

In the chart below, AGL Energy Limited (AGK) had a bearish market going into the middle of March 2011 when the On Neck Pattern struck. Price on the second day experienced a large gap down on the open before the bulls rallied to close just a single pip above the previous day’s low. In this kind of environment, the bears were probably expecting a continuation as per the nature of the pattern. The bulls would have been nervous on the third day when confirmation arrived as a long red candlestick and lower close. As Bulkowski’s analysis has revealed, however, the On Neck continues the current bearish market in only a little more than half of all instances. Thus, the confirmation serves to extend the bearishness for a day before price then hits an upswing for over the next two months. In this case, the On Neck played to the smaller odds (42 percent) that price would reverse or range. The bulls and bears fought to control the market for a few days after the On Neck formed, but eventually the long green candlestick on the second day proved to be a harbinger of coming bull strength.

 

 

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