Does reversal trading strategy actually work? What is the best way to spot reversals? Trading
reversals can be a difficult task and many traders will recommend trading the trend instead.
On the Trading Rush channel where we tested many different trading strategies 100 times
to find their win rates, I tested strategies as a trend following strategy and I used the
200 period moving average to do that. If you haven't watched them, go watch now, and subscribe
to the Trading Rush channel, because we test many strategies and trading indicators on
this channel to find their win rates and you don't want to miss that. But sometimes
trading against the trend can be more profitable if price makes a big move in the opposite
direction.
But as you already know, predicting a reversal point on a trading chart is almost impossible,
because if there is a catalyst moving the market, price can move in one direction for
a long period of time.
For example, let's say price is in an uptrend, it makes higher swing highs and higher swing
lows. Now, if the price starts to go sideways, some traders will look for reversal patterns
like the double top pattern. Double top patterns can be really effective when used correctly,
but in this example where the market is in a strong uptrend, how do you know the double
top pattern is formed at the end of the trend? There is a good chance the price can go sideways,
or give a small pullback instead of a reversal and can continue to move in the upward direction.
Because of this, new traders are usually recommended to trade with the trend.
Since trend is your friend, instead of trading against your friend, what if I told you, that
you can call yourself a reversal trader while trading the trend at the same time? Because,
that's what many professional traders do, especially the one selling the courses. Don't
get me wrong, there are reversal traders who trade actual reversals and make profits. But
then there are traders who will trade reversals and trend at the same time. This is one of
the most effective ways to catch the big move in trading. For example, let's say bill the
first wants to make money as a reversal trader. He finds a stock or forex pair where market
is in an uptrend. Similarly, there is bill the second, who also wants to trade the reversal.
He finds a different pair that is also trending upwards. At first glance, both of these charts
look very similar to each other. Lets say, when the market goes sideways, a double top
pattern is formed. Since double top pattern is a reversal pattern, both bill the first
and bill the second take a short position.
Now remember, both of these charts were in an uptrend, so when the double top pattern
occurred, on the first chart, instead of price making a big move down and starting
a new downtrend, price reacted to the trend line and moving average supports, and simply
went in the upward direction and continued its uptrend. On the other hand, price on the
second chart actually gave a reversal and made a big downward move. On the first chart,
bill the first made a loss. But on the second chart, even though the charts looked very
similar at the first glance, bill the second made a big profit.
In this example, to understand why one reversal worked and other one didn't, we will have
to switch to a higher timeframe.
If we look at first chart where bill the first lost money, you can see that the price is
in a strong uptrend on the higher timeframe. Furthermore, it has just touched a support
area and has enough room to move higher.
On the other hand, if we look at bill the second's chart on the higher timeframe, you
will noticed that unlike the first chart, this chart is in a strong downtrend. Not only
that, but it recently touched a strong resistance area.
On the first chart, even though there was a double top reversal pattern, the price was
in a strong uptrend on the higher timeframe which decrease the probability of giving a
reversal on entry timeframe. In other words, bill the first lost his trade.
Now on the second chart, even though we had similar price action, the price did make a
big move down and the reversal worked, because this reversal on the higher timeframe was
actually a small pullback reversal in a strong downtrend. And since this pullback reversal was
near a strong resistance area, the price made a big move down. In other words, bill
the second made money with the reversal, because he analyzed the market a little bit better
by using multi-timeframe analysis.
There are many people who will sell you a reversal course but you will probably never
make money, because in reality when they show you their reversal trades, the trades are
actually trend following setups on higher timeframes. They won't tell you this because
they want you to keep paying them money while you keep figuring out why your reversal trades
don't work.
There are trading setups that actually work without any multiple timeframe analysis. For
example, let's say there is a company whose stock has fallen due to some events. The company
has a good reputation and its stock was trading at 500 dollars at one point. Due to
some event that made the company employees stuck at home, the company made a loss, and
the stock price is now near the 100 dollars mark.
Now 100$ on a stock is a psychological number. Numbers with multiple zeroes at the end usually
work as a psychological support and resistance levels. Since this company had a good reputation
and will probably make money when the employees come back to work, people will be interested
in buying at the 100$ support level. Since we know this support level has a higher chance
of working, we can look for reversal trading opportunities near the 100$ mark. Even if
the price doesn't immediately make big move in the opposite direction, there is a high chance
that there will be a small push up, since many traders will be interested near this
level, as the 100 dollars mark will be clearly visible on all timeframes.
There are many other popular reversal patterns like the channel and the trend breakout. But
like I have said in my previous videos, just because a price breaks a tiny line you drew,
doesn't mean the price is going to make a big move in the opposite direction. Price
can simply move in the sideways direction, and most of the time, it does.
Reversals are part of trading, and there is a saying that goes something like "price can't
go in one direction forever, it has to reverse at one point". Well yes, but actually no.
It doesn't matter if the price can go infinitely in one direction or not, to trade reversals,
what matters is how accurately you can predict a reversal point in a trend. In reality,
most retail traders can't predict the accurate timing of a trend reversal, and even if they
could, many probably won't be able to tell if it's a reversal or just a small pullback.
When you see a reversal pattern such as a double top or double bottom, it is a good
idea to exit your open positions, instead of predicting the new big move with a new
position.
So, when trading reversals, it is a good idea to do multiple timeframe analysis to
get the big picture. Otherwise, there is a chance the you will end up trading against
a strong trend of the higher timeframe. Furthermore, since trend is your friend and since trend
is where most money is made, it is a good idea to trade the reversal of a pullback,
instead of trading the reversal of the entire trend. This way, you will have a higher chance
of making money in trading.
That's all. Now you know more about reversal trading. Like the video if you liked it, subscribe
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the Trading Rush channel to see more videos like these. You should check out the 5 steps
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