Reversal

A change of an asset price is known as a reversal. There are two descriptions that the reversal is likely to have, The first is upside, the second description is downside. Which one reversal in every case is defined by an uptrend and downtrend. In case there is an uptrend, a reversal would be called a downside reversal. In case there is a downtrend, a reversal would be known as an upside reversal. Note that you can’t take two bars on a chart in order to determine a reversal, for the reason a reversal can’t be based on such a little piece of data. It has to be based on overall price direction.

In order to recognize reversals and figure out whether a particular trend appears or not, some indicators like a moving average of an oscillator can become great helpers. Reversals are often compared with breakouts.

What Reversal may tell

Reversals may happen within different periods. It may be years, weeks, and even days. However, more often they are quite quick events and tend to occur within one day. Thus, different types of investors are guided by different reversals. For example, there is a five-minute reversal, long-term investors don't pay attention to it, they rather focus on daily or weekly results. On the contrary, traders are highly interested in such five-minute reversals since they are more useful for them.

There are always possibilities of an uptrend turning into a downtrend, and a downtrend becoming an uptrend. In fact, an uptrend is a sequence of higher highs and higher lows, it may become a downtrend by turning into lower highs and lower lows. The same may occur to the downtrend. Usually, it’s a sequence of lower highs and lower lows, it may turn into an uptrend by becoming higher highs and higher lows.

As it described above, price action may become a good helper in recognizing whether the reversal is about to happen or has already happened. However, it isn’t the only way to determine it. Some traders choose indicators as helpers. For example, there is an indicator, which is called moving average. It can help to identify whether there is a reversal or not. In case the price goes above an increasing moving average, then it refers to the situation in which the trend is up. In case the price decreases below the moving average, it may be a sign for a price reversal. Another way to identify reversals is to pay attention to trendlines. Trendlines may be placed along higher lows for the reason they form these higher lows. Situations, in which the price falls lower than the trendline is, may signify that a reversal is about to appear.

It may seem quite easy to spot a reversal using indicators or such things as price action, but in reality there are many other factors that may become great obstacles on the way of a successful trader or investor. Some of these disturbing factors are noise, brief pullbacks, etc. They complicate the investment, creating false signals and confusing investors. Another thing that makes investment more difficult is the fact that a reversal sometimes may happen in such a short period of time that traders don’t even have enough time to spot it. Thus, traders are likely to become victims of such a speed and incur large losses.

How Reversal is different from pullback

While a reversal is a trend, which affects an asset price, a pullback refers to a counter-move phenomenon that is happening within a one trade. Pullback isn’t regarded as something that can reverse the trend. The things that form an uptrend are higher highs and higher lows. A pullback is made of higher lows. Thus, an uptrend can’t reverse until the price meets a lower low for the time period a trader monitors. However, the beginning of a reversal and the beginning of a pullback are quite similar. Thus, it’s hard to distinguish them before the start.

What limits Reversal has

If a reversal exists, it means that a financial market is alive and active. There is no time when prices are stable, they are always likely to fluctuate. Thus, both kinds of reversals (upside and downside) aren’t rare occasions. Reversals can’t be neglected, since the more you ignore them, the more risks are being involved. For instance, a trader may monitor a stock, it has significantly moved, the new price is twice higher than it was before. For this reason, the trader expects the stock to grow even higher, since it seems solid to him or her. However, then the stock drastically falls to the previous price level and even to the lower one. Such dropping signals are quite obvious for some investors. Even before the jump of the price, the potential reversal might have been clear. As the result, monitoring and analyzing reversals may bring success to any trader or investor, it helps to lock in profit and to maintain the current positions.

Moreover, as it was mentioned in the previous paragraph, it’s difficult to say for sure whether the happening trend is a reversal or pullback before it starts. A trader might identify that it was a reversal when it’s too late and when it has already resulted in significant losses. Therefore, exit strategies are existing and most of the trend traders use them in order to exit while the price is growing, and before it falls, and otherwise. This strategy relieves the necessity to worry whether it’s a reversal or pullback.

One more limit is a false signal, which is quite often as well. Reversals can be detected with the help of an indicator, and some time later the price may regain its previous direction.