direction relapses indicate where condition The current trend changes direction Either suddenly or over a long period of time. When caught earlyReversals can be very profitable in the market.
For example, if a company’s share price is in a strong upward trend, a reversal would see the start of a new downtrend.
A good example of a trend reversal is shown in the chart below.
As you can see, the NASDAQ 100 has been in a very downtrend in 2022. This decline has taken it as low as $10,437. Then the index came back strong and rose to nearly $14,000 in May 2023.
In this article, we will look at what a trend reversal is, how it works, and the rules to use when using the strategy to trade.
Definition of trend reversal
As explained above, a trend reversal pattern is defined as a situation where the current trend changes its direction and starts a new one. As shown above, the NASDAQ 100 was in a strong downtrend in 2022 and then made a strong trend reversal in 2023.
relapses It happens in all timeframes, including weekly, daily, hourly and even in one minute chart. Another thing is that reversal pattern Lead to trend following strategy.
This means that once you spot a reversal, the next strategy is like following the trend because your goal is to do so Hold it until another reversal occurs.
Determine the current trend
The first step in trading trend reversals is where you are Determine the current trend. This is an easy step where you can see the direction visually. For example, as shown above, we can see that the NASDAQ 100 is clearly moving in an upward trend on the daily chart.
However, there are other things that can help you at this point. Firstly, Look at the period specified in the diagram. This is important because a stock can be in an uptrend on a 5-minute chart and be in a strong downtrend on a daily or weekly chart.
Secondly, you need to Understand why an asset is in an uptrend or downtrend. Finally, some trend indicators such as moving averages and Bollinger Bands can help you identify these trends.
Identify the main reversal patterns
The other rule to keep in mind is that you need to Identify the main reversal patterns In the market. These patterns will be useful when using trade reversals.
There are many such styles, including:
- Double and triple bottoms
- Head and shoulders
- The rising and falling wedges
- gap reflection
- Pivot point reflections
- price action reversal patterns
Among other things.
For day traders, you should focus on chart patterns that appear on very short-term charts such as the 5-minute or 1-minute charts.
In this case, you should Focus on Japanese candlestick patterns Such as the Hammer, the Doji, the Shooting Star, the Evening Star, and the Morning Star. In the chart below, we see that the NASDAQ 100 formed a Doge Candle followed by a small hammer. these patterns are some of the best reversal patterns.
Use volume
Volume is an important aspect when trading reversals. In most cases, traders confirm when an asset is about to reverse When there is enough volume. For example, if a reversal pattern forms and is not supported by volume, this is a sign that this is going to be a false reversal.
Fortunately, many brokers provide information on the amount of assets. If a major movement occurs Without enough volumeit means that this new This move probably won’t be a strong one. On the other hand, if there is more volume, it means that the price is likely to continue in the new direction.
A good example of this is shown in the BTC chart below. As you can see, the BTC/USD pair They formed a shooting star pattern in a large scale environment. Since the volume was high, the pair continued to decline, confirming the trend.
Use technical indicators
The other important rule is that you must Use technical indicators to identify and confirm trend reversals.
There are several types of technical indicators that you can use in day trading. The most common are:
- Moving averages
- VWAP
- The relative strength index (RSI).
- Stochastic oscillator.
All these indicators used differently. Trend indicators such as moving averages are used to identify and confirm trends. Oscillators Such as the Relative Strength Index (RSI) and the Stochastic Oscillator Mostly used to find overbought and oversold levels.
For short-term traders, we recommend using short-term indicators. The most popular reversal indicators in day trading are the VWAP and moving averages.
Focus on the news
The other important thing that you need to consider when trading reversals is Focus on the latest news. there Numerous news events affecting asset movements Such as corporate earnings, interest rates, geopolitical events, inflation data, and employment functions.
For example, in the Nasdaq 100 chart above, we see that the index crashed hard in 2022 as the Federal Reserve raised interest rates. In 2023, it has bounced back amid hopes that the Fed will begin to pivot.
Therefore, always be in Learn about the latest and upcoming news In the market. Using major calendars such as the earnings and economic calendar will help with this.
summary
In this article, we’ve looked at the concept of reflections and how they work. We also looked at some The best rules to follow When using the reversal technique in trading.
The bottom line is that the reversal technique can be very profitable but one needs to follow several rules to use it effectively.
Useful external sources
- Top 3 early signs of a stock reversal – Trade smart