How to identify market reversal

How to identify market reversal

A trend is a major state of the market, so every trader needs to understand trends well. No trend will last forever: there will always be a moment when the trend you are trading reverses and a new trend starts.

Technical analysis can tell a trader whether a trend is close to changing its direction or confirm that a reversal has indeed happened.  

A trader needs to know about an upcoming reversal for two reasons. Firstly, if a trader is already holding a position on a trend, he/she will want to exit it before the reversal. Secondly, the reversal is a time when a new trend emerges. If you read the market correctly and spot it in time, you will get an opportunity to join the trade early and gain more.

The probability of a reversal largely depends on the strength of the current trend: if a trend is weak, the reversal is more likely. There are several ways to estimate how strong a trend is. We can recommend two tactics: visual analysis and technical indicators. 

Visual analysis of a potential reversal

Look at the highs and the lows of a trend. If the corrections are short, and the consolidations develop in narrow ranges, the trend is strong. In a strong bullish trend, the price strictly respects the first support formed at the previous highs:

r strong.png

In case of a slow uptrend, the price can fall below the previous high (the initial support) but holds above the previous low. 

r2.png

A weak uptrend can be recognized by the presence of a lower high. In this situation, traders will be afraid of the formation of the “Head and shoulders” pattern and the potential reversal of the market to the downside.

r4.png

In addition, when the price starts revisiting a support line too often, it is a hint the uptrend is getting weaker.

As you can see from the explanations above, it’s necessary to distinguish between support #1 (previous high during an uptrend) and support #2 (previous low during an uptrend). A reversal happens when the price breaks support #2. Two situations are marked at the picture below. In the first case, the price has managed to stay above the second support. In the second case, it went below the second support and confirmed a reversal.  

Screenshot_25.png

Notice that it’s very important to confirm that the price did indeed break below support/above resistance to declare a reversal. Take a close look at the Japanese candlesticks: the breakthrough candlestick should close below the support/above the resistance. An ideal situation is when the broken line is retested, but the price doesn't return above/below it. Breakthrough confirmation may also come from technical indicators and volumes.

Indicators that can help you identify a reversal

There is a number of technical indicators that may be quite helpful for identifying a reversal.

First of all, Moving Averages of various periods can either provide support/resistance levels beyond which traders will see a reversal or intersect sending the signals of a trend’s change. The Ichimoku indicator also has a set of lines which indicate when the market switches from the bullish to the bearish mode and vice versa.

Secondly, ADX is a leading indicator of a trend’s strength. The main line of the indicator rises when the trend is getting stronger. The ADX magnitude varies from 0 to 100. If the indicator is above 25, a trend is distinctive and strong. The moment when ADX rises above 25, it may be used as a confirmation of a breakout and trend reversal. The direction of the reversal may be shown by the two other lines of the indicator.

r5.png

It’s also worth monitoring how ADX itself is trending. If the indicator forms a series of higher peaks, the trend is strong and a reversal is less likely.

You can also use volume indicators to estimate trend strength and confirm reversals. If a lower high was formed in an uptrend and the volume is lower as well, it’s a strong hint of a reversal to the downside.   

Reversal or correction?

The main problem is that reversals often start as corrections. As a result, it’s often quite difficult to distinguish one from the other. In the table below we have assembled the information that will help you do that.

tyei (2).jpg

Notice that corrections are relatively short-term. Their nature is technical: corrections occur when the asset gets overbought or oversold as market players take profit after a move in line with the trend. It might be helpful to use Fibonacci tools to measure the depth of corrections. When price retracement is contained by 38.5% Fibo, the current trend is fairly strong and there are no signs of a reversal.

Reversals, on the other hand, represent a bigger change in the direction of the price action and are often caused by some fundamental reasons. The key feature of a reversal is that the price goes beyond the key support/resistance of a trend. If the market goes beyond the 50% Fibonacci retracement level, this might be a reversal.

Conclusion

All in all, to increase the precision of your forecasts, we recommend you using several methods of analysis to determine reversals correctly. Remember that the described methods do not guarantee a 100% chance of success, so it’s necessary to abide by the rules of risk management when you trade reversals.  

Latest news

Retail data may shake the loonie

Canada will publish the headline and core retail sales on January 24 at 15:30 MT time. 

The ECB and the euro: surrounded by skeptics

The European Central Bank will publish its monetary policy statement and announce the main refinancing rate on January 23 at 14:45 MT time.

Will the BOC bring a challenge to the CAD traders?

The Bank of Canada (BOC) will release its rate statement alongside the monetary policy report during its meeting on January 22 at 17:00 MT time. 

লোকাল পেমেন্ট সিস্টেম দিয়ে ডিপোজিট করুন

Learn more

কলব্যাক

ম্যানেজার শীঘ্রই ফোন দেবে।

নম্বর পরিবর্তন করুন

আবেদন গ্রহন হয়েছে

ম্যানেজার শীঘ্রই ফোন দেবে।

অভ্যান্তরীন ত্রুটি দেখা দিয়েছে। অনুগ্রহ করে কিছুক্ষণ পরে আবার চেষ্টা করুন

নতুনদের জন্য ফরেক্স বই

Beginner Forex book will guide you through the world of trading.

নতুনদের জন্য ফরেক্স বই

ট্রেডিং শুরু করতে সবচেয়ে গুরুত্বপূর্ণ জিনিসসমূহ
আপনার ই-মেইল দিন, আর আমরা আপনাকে ফ্রি ফরেক্স গাইডবুক প্রেরন করবো

ধন্যবাদ!

আমরা আপনার ই-মেইলে বিশেষ একটি লিংক প্রেরন করেছি।
সেই লিংকে ক্লিক করে ইমেইল নিশ্চিত করুন আর নতুনদের জন্য ফ্রি ফরেক্স গাইডবুক নিয়ে নিন।

আপনি পুরনো ভার্সনের ব্রাউজার ব্যাবহার করছেন।

লেটেস্ট ভার্সনে আপডেট করুন অথবা অন্য একটি ব্যাবহার করুন সুরক্ষিত, আরো সুবিধাজন এবং ফলদায়ক ট্রেডের অভিজ্ঞতার জন্য।

Safari Chrome Firefox Opera