Reversals are the events when an ongoing trend terminates, and a new trend in the opposite direction emerges. As we have noted that the price tends to move in waves, and it ebbs and flows. More often than not, the convictions behind the original trend dry out, and the market in reaction reverses the price direction. Reasons behind these reversals can range from random fluctuations to shifts in underlying fundamentals.
You cannot correctly identify every possible trend reversal, but you can look for traits some Reversals showcase. Firstly, the prior trend should show some evidence of maturity. A Trend becomes mature when it had gone through many legs and had been there for a while.
Sometimes when Trends are about to exhaust, the last few candles undergo very aggressive moves, signaling a climax. Sometimes the price would make an extreme (a new high or low), and then the price would fluctuate below that level.
A more advanced trait is Momentum divergence when a momentum indicator (Like RSI, MACD, Stochastic Oscillator, etc.) disagrees with the price.
A handy tool to decipher big and small trend reversals is the Trendline. Just connect lows of an uptrend/ highs of a downtrend in a roughly fitting line. If the price crosses over the Trendline, you have a Reversal opportunity.
The best aspect of Reversal trades is that their stop is clearly defined. The region near the extreme serves as the stoploss. It is also worth noting that this region is susceptible to gaps at higher time formats, so keep your overnight positions lightweight.
Another entry opportunity is when the price gives its first pullback after a reversal. By the time this pullback comes, we know that the mood has changed and has some chance to continue in this new direction.
Two things can go wrong: 1) Price moving in the direction of the original trend, in that case, it crosses our stoploss. 2) Price not moving as expected, and forms a range. In both the scenarios we exit.
We will explore trading ranges and complete your market-vocabulary. Learn!