Trend reversals happen when a downtrend changes into an uptrend or vice versa. Price tends to reverse after attaining its overbought and oversold levels. In this lesson, we will discuss ways on how to identify a trend reversal.
A trend reversal is a change in the direction of a price trend.
As price completes its trend movement it shows weaknesses by forming tops and bottoms patterns, crossovers in the indicators and also reduction in the price volume and momentum. This clearly signals that one party is losing control of the market. In this case you can easily identify a trend reversal.
The appearance of reversal candlestick patterns always give a strong confirmation for a trend reversal. When you see candlesticks like shooting stars, doji, hammer, engulfings and stars forming especially on critical levels of support and resistance, it is always important to watchout for the next move.
Let’s have a look at an example on the chart below on AUDNZD, Daily timeframe.
So from above chart, how do you identify a trend reversal? Take a closer look at the candlestick reversal patterns formed at support and resistance zones. These resistance and support zones are usually previous lows and highs. That’s a warning for a trend reversal
Once you learn how to spot a reversing trend, you will be able to prepare for the probable changes in the market in case you are holding an open position and to prepare for new coming opportunities.
For a downward trend to reverse, price falls to a point where it is likely not to be accepted in the market. A further fall in prices, sellers are not willing to sell. Their stock or currency is being under valued causing most of the sellers to give up on the market.
As a result demand becomes greater than supply causing imbalance of supply over demand. This causes a reversal in favor of buyers( uptrend).
For an uptrend to reverse, prices must have been increasing up to a point where buyers are not willing to buy at any additional raise in prices. This will ultimately lead to price fall. Currency is over valued causing more of the buyers to give up and wait to buy when prices fall.
This reduces on the strength of the buyers in the market causing supply to be greater than demand due to expensive prices. As the sellers out number buyers, it will cause a panic in investors to sell their currencies high and this is likely to cause a sharp fall in prices as more sellers get into the market.
How to identify trend reversals in the market?
Trend reversals conditions can be identified by studying price action in the current market trend for instance;
- Looking at the weaknesses in the trend movements. If price was making higher highs and higher lows in an uptrend but starts making lower highs and lower lows its an indication that a trend is likely to change direction.
- The appearance of small candlestick patterns in the trend especially on the levels of support and resistance such as shooting stars, doji, hammer, spinning tops and stars. This is also an indication of indecision or equal powers between the buyers and sellers, the strongest determines the direction of the trend.
- Indicators showing over bought and oversold conditions
Take a look at the AUDNZD, Daily chart below
The chart above shows trend reversals at the levels of support and resistance. The blue arrows shows price movement in an uptrend and the red arrow shows a downtrend.
So as price comes back to these zones especially after a trending movement, it likely reverses. This means that these are important levels to watch.
You will be able to prepare for the probable changes in the market in case you are holding an open position or prepare for new coming opportunities.
How long you should hold an open position, is a personal thing for all traders. The decision is all yours. You know what your goals are as a trader, the kind of strategy you use to trade. All this starts from what you are? and What you want? If I am to answer, this...