Reversal Trading Strategy in Forex and other Markets
Reversal trading is one of the most profitable trading strategies you can use. You can use Reversal Trading in trending markets, ranging markets, and even against the trend. And also in many different markets, including Forex, stocks, and cryptocurrency, and you can use it on all time frames.
What is a Reversal Trading Strategy?
When using a reversal trading strategy, you look to gain profits when the price reverses its direction. Traders often get confused about when reversal trading is trying to pick the market top or bottom or looking for a trend to change.
For example, if you are looking to make a reversal trade within a trend, you would be first looking to identify the overall trend. In the example below, price is forming a clear trend higher with higher highs and higher lows.
To make a reversal trade on this trend moving higher, we wait until the price comes back lower into a value. This is usually a support or resistance level. Then we can enter long trades from the swing low and looking for price to reverse back higher in line with the trend’s direction.
How to Identify a Trend Reversal
Very often you will get the chance to make reversal trades when a trend is coming to an end. Taking trades against the trend that is currently in place can be risky, yet, it can likewise accompany higher rewards. If you can catch a new trend when it is first starting, then you often have the chance to drive a large winning position.
Two popular strategies to recognize when a trend is about to reverse are the moving average crossover strategy and the 123 trend reversal strategy.
123 Trend Reversal Pattern
The 123 trend reversal pattern is a price action pattern that shows the trend could change. With this pattern, we have three different moves.
In the following example, we see a 123 trend reversal to the upside. After forming a trend, a lower price makes its first leg higher and followed by the second leg and swing lower. The reversal and pattern are complete when the price moves higher in the third leg, and it takes out the high of the first leg making a new higher high and new short-term trend.
Intraday Reversal Trading Strategy
Reversal Trading can be worked out on all the time frames from the higher time frame charts, such as the daily chart, to the 30 minute and 15 minute charts. The key when reversal trading on the lower time frames is to use the major levels as a guide and if there is any clear momentum to trade with it and not against it.
In the first example shown below, the price momentum had been trend higher. With considering this, we would be looking for long trades. When the price moves back lower into a support area, we could look to make long trades. Then we would be looking for price to reverse back higher with the overall momentum.
In the second example, there is no definite momentum or trend in play. Because of that reason, we are looking at the clear support and resistance level for potential reversal trades.
When price moves lower and into the intraday’s range support level, we could start looking for potential long trades and profit as price reverses back higher away from this support.
The Best Trend Reversal Indicators
Moving average strategy is one of the most popular technical indicators that are used across all markets. Moving averages are used to find out the overall price action and give you an idea of the market trend. They can also help you recognize how strong a trend is and if that trend could be slowing or coming to an end. When using multiple moving averages in your trading, you can use them to make out the trend reversals and reversal trades.
Another reputed indicator used across all market types for spotting new trends or momentum is the MACD. The MACD shows the information from two different moving averages and how they work together.
The MACD oscillator on your chart moves above and below 0. With this information, you can begin to make out new trends forming and when momentum is building for potential reversal trade setups.
A Simple Reversal Trading Strategy
Using Fibonacci and Price Action strategies
The Fibonacci tool is one of the simplest ways you can find high probability reversal trades on all of your different time frames. The Fibonacci indicator can help you recognize when the price is likely to find support or resistance and could be about to make a new reversal.
In the example shown below, the price is in a trend higher. Just after the price pulls back lower, we see that it moves into the 50% Fibonacci level. We could initiate by looking for long reversal trades at this retracement level in line with the trend higher.
Range Reversals From Key Support and Resistance Levels
Range trading reversals is another strategy that can be used on all of your time frames. You can use it to Scalp if you are more suitable for shorter time frames or swing trade with it if you prefer higher time frames.
In the example shown below, we have a clear range of support and resistance.
As the price moves into the range of high resistance level, we could start to look for short trades and for the price to reject this resistance and reverse back lower. We could then be looking to gain profits as price reverses back into the range’s low and support level.