When it comes to strategy, reversal trading is a tried and tested method proven, when executed correctly, to be one of the best ways to trade forex. But what is this popular trading approach and how can you incorporate this useful weapon into your daily forex arsenal? Luckily, today we’re showing you how by helping you understand why this advanced strategy continues to have profitable potential.
So first things first, what actually is reversal trading?
In layman’s terms, a reversal trade is a setup that reverses (either up or down) the direction a price has been moving in. It capitalises on advantageous market entry, opening a position at a prosperous price and riding the momentum to profit, sell or buy when the market is about to reverse direction.
A reversal is identified by observing your forex signals, with a price falling from an established high in a bullish market or, juxtaposingly, rising from an absolute low amidst downtrend in a bearish market.*
*Not yet familiar with all the day to day trading jargon? Not to worry! We’ve put together an industry glossary detailing an array of definitions for the most commonly used words, terms and phrases within the world of forex – you can find it right here!
How do I spot these reversals?
While it’s easy to identify reversals after they happen, the real skill is recognising them as they develop. After all, that’s where the potential profit is made! Check-in with your forex indicators and charts, keeping the following at the forefront of your observations:
Downtrend – This is defined by a recurring series of lower highs and lower lows, with the market eventually hitting rock bottom with an absolute low price value. From here, a reversal takes place with an upward trending price action, establishing a recurring series of higher highs and higher lows
Uptrend – In contrast, uptrend is a consistent series of periodic higher highs and lower lows. Subsequently, the market eventually reaches an absolute high value price, where a reversal then occurs marked by the downward trend of price of action
When do these reversals happen?
Market direction changes frequently, with reversals occurring suddenly within seconds or as a result of gradual development. All it takes is an imbalance of supply and demand caused by an increase in participation. As a rule of thumb, there are 2 main forex indicators that signal the possible occurrence of a market reversal:
Technicals – To the strategically sufficient analyst, technicals can serve as clear reversal drivers. From pivot points to moving averages, a technical analyst can interpret plenty from their forex charts to accurately predict when a market reversal may take place
Fundamentals – The less experienced forex trader should instead turn their attention to fundamentals as a means of predicting a market reversal. Consider external and internal events that may have an impact on the market – anything from changes in monetary policy to breaking news can wreak havoc on the stability of a market’s direction
Though a single event can (and indeed has and will) cause a market reversal, a reversal is more commonly a cause of the convergence of both technical and fundamental factors.
So when do I trade?
In essence, reversal trading is a counter-trend method.
A trader enters the market against a price momentum, which greatly increases their risk of sustaining large drawdowns. However, this tactic can prove especially profitable if timed correctly – as such, timing is everything. When implementing a reverse trading strategy, be sure to consider the following:
Risk/reward – As mentioned above, reversal trading can be a risky strategy, leaving you open to potentially quick losses. Though this should be the case in all trades, adherence to risk vs reward consideration is consequently vital before placing a reversal trade
Trade selection – In order to obtain any considerable success through this strategy, you must be sure the accelerants of market reversal are at play. The convergence of fundamentals and technicals may provide credence to a directional change, so be sure to keep one ear to the ground at all times and time your trades perfectly
The modern digital forex market moves fast, with high levels of speed and velocity. Subsequently, reversal trading can be a risky and potentially dangerous strategy when not executed to perfection. As such, why not look to brush up on your forex knowledge and strategy by attending one of our free two-hour educational seminars? You can sign up right here!