A reversal pattern indicates a change in direction from a rising market to a falling market and vice versa. We can use this pattern to predict the upcoming movement and open or close our trades accordingly. The Reversal patterns suggest that the ongoing trend is about to change its course. These patterns can appear in an uptrend and downtrend. There are basic two types of trend reversal patterns; the bearish reversal pattern and the bullish reversal pattern.
What are the Reversal patterns?
The Reversal patterns describe the change in trend by moving against the current direction. The trend pauses for a while and then heads in the opposite direction. These patterns identify that either bulls or bears are losing the battle. For example, in an uptrend, the bulls are in control, but after the appearance of Reversal patterns, bulls lose the battle to the bears, and the market goes downward.
Forex reversal patterns are on chart formations which help in forecasting high probability reversal zones. These could be in the form of a single candle, or a group of candles lined up in a specific shape, or they could be a large structural classical chart pattern.
Each of these chart formations has a specific reversal potential, which is used by experienced traders to gain an early edge by entering into the new emerging market direction.
1. Head and Shoulders
The head and shoulders establish at the top or bottom and signal a potential change in the trend. It consists of a series of peaks and troughs, and two trendlines are drawn at the pattern.
The typical head and shoulders occur in a downtrend, while its variation in inverted head and shoulder emerges in an uptrend.
2. Double top and bottom
The double tops and bottoms mention that the price made two failed attempts to break through support or resistance levels.
The double top resembles M and attempts to break through the resistance level. It is a bearish reversal pattern. On the other hand, the double bottom looks like W and fails to push the price at the support level. It is a bullish reversal pattern.
3. Falling and Rising Wedge
The wedge patterns are drawn by two trendlines, either ascending or descending.
In the falling wedge, the two trendlines are descending, representing highs and lows. It is a bullish reversal pattern.
How to use the Reversal patterns?
To utilize reversal patterns, a neckline is drawn on them. A neckline forms at a support or resistance level and determines an entry point for the reversal patterns. If the price moves below the neckline, it’s a signal of a downtrend. When the price moves above the neckline, it signifies an uptrend.
The entry points should be made not at the neckline, but above or below it. As for the stop-loss, a trader can measure the distance of reversal patterns from the neckline, dividing it by two, and then place a stop-loss.
A keynote to add here is the reversal patterns do not always illustrate a change in direction. Sometimes, even though a reversal pattern forms, the price continues to move with the trend. This is where a trader needs to be careful and canwait for the confirmation of the trend. A trader can confirm the trend by using technical indicators like the MACD or the RSI.
One of the most effective tools for spotting a reversal is also the most simple: the trend line. A trend line connects intermediate lows or highs of a financial instrument; in an uptrend, it connects lows (or troughs), while in a downtrend it connects peaks. If share prices punch through a trend line, the trend may well be broken.
Reversal patterns trading strategy
By identifying key reversals, a trader can improve his/her trading strategy. When finding these patterns, traders should look for a shorter price reversal, rather than a longer one as longer reversals can give false signals. The confirmation of every reversal candle pattern we have discussed comes from the candle which appears next, after the formation. It should be in the direction we forecast.
Reversal patterns buy strategy
- Locate the pattern in a downtrend.
- Wait for the price bar to go bullish before entering.
- Enter the trade above the neckline.
- Place a stop-loss near the recent low from the neckline.
- Exit the trade when the trend changes.
Reversal patterns sell strategy
- Locate the pattern in an uptrend.
- Wait for the price bar to go bearish before entering.
- Enter the trade below the neckline.
- Set a stop-loss near the recent high from the neckline.
- Exit the trade when the trend changes.
Reversal patterns conclusion
Reversal patterns are those chart formations that signal that the ongoing trend is about to change course. If a reversal chart pattern forms during an uptrend, it hints that the trend will reverse and that the price will head down soon. If identified correctly, reversal patterns can help spot market reversals. Traders should be careful about false signals, as sometimes a trend may not change. A pullback is temporary in nature within the cycle, whereas reversals are changes of the cycle itself.
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