A Guide On How To Identify Trend Reversals

You might be forced to ask, is it possible to identify a change in trend ahead of time? You also might be wondering, how exactly are all these forex gurus able to identify a change in trend before it happens? Guess what?

No one is able to identify a change in trend ahead of time or before it happens. No forex guru, no matter how experienced they can be able to identify a change in trend ahead of time.

Also, there is no indicator that is able to identify a reversal ahead of time.

The market only provides signals that help traders spot change in trends.

The advantage there is, the earlier you’re able to spot a reversal or change in trend, the higher your return on investment (ROI).

The unanswered question now is, what signals do the market present to traders that help them spot a reversal quickly?

In this article, you would be learning what these signals are, how to spot changes in trend quickly, and more importantly, how to use them in your trading.

What Is a Trend?

Before we go into what a trend reversal is, let’s define what a trend is.

A Trend in Forex Trading is defined as the strong or impulsive movement of a financial instrument in one direction, which can either be upward (uptrend) or downward (downtrend).

This impulsive movement can continue for days, weeks, months, and even years (such as the S&P 500).

But how do you identify a trend?

In an uptrend, there is the presence of more bullish candles than bearish candles and these bullish candles are comparatively larger than the bearish candles

Conversely, the presence of more and bigger bearish candles than bullish candles indicates a downtrend.

Then, what is a trend reversal?

What Is a Trend Reversal?

While the price of a financial instrument is moving in a particular direction that has lasted for some time, (days, months, weeks) the market can show a very significant move that causes the price to change in direction. This is known as Trend Reversal.

For example, when a price that has been moving upward starts to experience a significant downward movement, the price can be said to have experienced a change in trend.

Below is an example

Due to the fact that we have different types of traders, trend reversal can be subjective at times. This happens because they are looking at different time frames.

For example, a change in trend in a 5-minute time frame can be significant to a day trader, whereas a swing trader might not perceive it this way because their investments are not affected by daily price fluctuations.

In forex, some people fall into the trap of believing that every change in price direction is a reversal. This can be false at times.

Why?

This is because there are counter-moves known as pullbacks and retracements.

The difference between these movements and trend reversals is that these price movements often linger for a short period of time and do not have a significant change in the overall direction of price movements, whereas trend reversals last for a long time and affect the overall trend of price.

Like earlier said, these are the traps that most traders fall into when they are not able to spot the difference between trend reversals and movements such as these.

The ability of a trader to spot these differences could determine how profitable they can be over a long period of time.

How To Identify a Trend Reversal.

There is no method or strategy that can guarantee 100% accuracy in the identification of a trend reversal.

The most these methods can do is help you identify strong potential areas for trend reversals. The three most accurate and profitable methods of identifying a change in trend in my experience are;

1. Candlestick patterns

2. Chart patterns

3. Technical tools

Candlestick Patterns

In forex generally, candlesticks are what traders look at in order to make a conclusion about what is going on in the marketplace.

There are also some specific candlesticks that have a lot more information than just being a candlestick.

These common repeating candlestick patterns help traders identify potential trend reversals. They are known as REVERSAL CANDLESTICK PATTERNS.

Some of the major reversal candlestick patterns are engulfing, morning and evening stars and the rejection candlestick patterns.

Engulfing Candlestick Patterns

The engulfing candlestick patterns usually involve two candlesticks in which one totally engulfs the other. These candlestick patterns are of two types, the bullish engulfing and the bearish engulfing candlestick patterns.

The Bullish engulfing pattern helps to show an opposite change in direction of a bearish trend and the beginning of an uptrend.

Example

The Bearish engulfing pattern indicates the end of a bullish run and a change in direction to a bearish trend.

Example

The Morning and Evening Candlestick Patterns

This candlestick pattern involves three consecutive candlesticks in which the middle candlestick is an indecision candle.

The morning star helps to indicate the end of a downward trend and the beginning of an uptrend.

Example

The evening star helps to indicate the end of an uptrend and the beginning of a downtrend.

Example

The Rejection Candlestick Patterns

There are two major types of rejection candlestick patterns which are the hammer and shooting star.

These candlesticks help to show the strong unwillingness of price to continue in a particular direction.

The Hammer candlestick pattern is a bullish reversal candlestick pattern that helps to show the unwillingness for the price to continue lower and the tendency for the trend to be reversed.

They are usually located at the end of a bearish trend and are characterized by a long lower shadow, a small body, and little to no upper shadow.

Example

The Shooting Star is a bearish reversal candlestick pattern that indicates the reluctance for the price to continue going higher and shows a potential trend reversal from that spot.

They are usually located at the end of a bullish trend and are characterized by a long upper shadow, a small body, and a little to no lower shadow.

Example

Chart Patterns

Chart patterns are known as recurring recognizable patterns that form on the chart. Basically, these chart patterns help us to spot explosions even before they happen. They are also strong indications of potential trend reversals.

There are many of these chart patterns that indicate reversals but we are going to be looking at the ones that have been found profitable.

They are Head and shoulders, double tops and bottoms, and triple tops and bottoms.

Head and Shoulders Pattern

Head and Shoulders pattern forms at the end of an uptrend.

This pattern has a close resemblance to the upper torso of a person. It has a left shoulder, a head, a right shoulder, and a neckline.

The formation of this pattern indicates that the price has ended its rally and a downtrend is about to begin.

Example

The opposite also happens for the Inverted Head and Shoulders pattern.

Double Tops and Bottoms Pattern

Double tops form at the top of an uptrend usually when the price gets to a major resistance level. When the price gets to this level, declines a little bit, and retests this level without bridging this level, it forms a double top.

When a double top is formed at this level, it is an indication of a potential breakout to the downside.

The opposite of this is true for a Double Bottom.

Example

For a triple top, the price hits the resistance level declines, and returns there two more times after a relative decline in price. This indicates a potential breakout to the downside.

The opposite of this is true for a Triple Bottom.

Example

Technical Tools

There are some technical tools that help to indicate a reversal in trend. Tools such as trendlines, support, and resistance.

Trendlines

Trendlines are the lines drawn at the external points of a trend.

They can be drawn at the upper price points or the lower price points. When they are both drawn, they show a Trend channel.

Trendlines are drawn by connecting the first two points of a trend. An upper trendline can be drawn by connecting the first two high price points and extending them.

Similarly, a lower trendline can be drawn by connecting the first two low price points and extending them.

For a trend reversal to occur, either the upper or lower trendline has to be completely broken for the price to start moving in the opposite direction.

For instance, if there is a breakout with higher lows and higher highs, then you can expect a downtrend reversal to occur. When there are lower highs and lower lows, it means an uptrend reversal is about to occur.

You must confirm that a trendline has been broken before taking a trade against the trend because there are also false breakouts.

Support and Resistance

Support is a zone where the price has been unable to break to continue lower, while Resistance is a zone where the price has not been able to continue higher.

When a trend continues on its course, it gets to a phase known as the distribution phase, at this point the buyers and sellers are pretty much in equilibrium.

The use of support and resistance is very necessary because it helps to mark out this phase correctly.

Let’s take a bullish run for example

When it gets to its distribution phase, we use support and resistance in marking out this phase.

The break of the support zone indicates that the price is about to explode to the downside.

How To Identify Strong Areas of Trend Reversal

By now, I’m quite optimistic that you have learned different techniques and signals of how to identify a potential area of a trend reversal.

But there is a little caveat;

The best way to find a strong area of reversal is the combination of these different techniques. The use of only one of these techniques will not give a strong area of reversal.

Let’s have a look at some very juicy examples of how to combine these different techniques.

Summary

You need to understand that there is no guru, no technique or indicator that can guarantee 100% accuracy on how to identify trend reversals.

The most reliable method is the combined use of price action and technical tools.

When trying to spot a reversal below are things you need to take note of:

· Identifying reversal candlestick patterns

· Identifying reversal candlestick chart patterns

· Break of major trendline

·  Break of major support and resistance level

The more confluence, the stronger the area of a trend reversal.