first, let me ask you a quick question when you're trading
have you ever encountered a situation where you took a buy position when the
price was on an uptrend only for that trend to reverse downwards which leaves
you holding at the top if so I know it's frustrating because I've been there
before and so after countless hours of research and backtesting I actually
found a strategy that you can use to predict these reversals before they even
happen so strap in because we're going to go very in-depth in this article so
first, let's start with the basics of what is a reversal so a reversal simply means
a change of trend direction
In this example we have an uptrend that switches to a downtrend
then you got yourself a reversal simple now a common mistake that traders make
are they think that because the price has gone too high then it's automatically
going to reverse this is actually the wrong mindset to have because think about if prices are going higher and higher it means that the upwards momentum is
strong so if you tried shorting this market just because you thought it was too
high then you're actually trading against a trend which is not a good idea
remember prices can always continue higher so with that being said here is a
couple of strategies that you can use to predict reversals before they happen
the first one is called brick of structure and this is how it works so first in
order to spot a reversal the first step is you want to find an existing trend
and in this chart, we actually spotted a clear uptrend here notice
how the price is structured it formed higher highs while
respecting this bottom level meaning we can also draw an upward trend line
below it now here's what you need to remember as long as the price remains
above the trend line, it means that the uptrend is still valid so in order for
us to find a reversal the price has to break the trend line first and so we
want to wait until the price breaks the trend line as you can see here but be
cautious just because the price broke out of the trend line doesn't mean that a
reversal will happen because even though the short-term trend is down the
long-term trend is still up meaning that the price still has a chance to go
back upwards so to confirm that the price will not go back upwards we need to
wait for signs of momentum loss so
let's let the price run until we find a confirmation now
notice the price tried pushing back up and failed then it tried again and
failed the second time which created a double top pattern here indicating that
buyers aren't strong enough to push the price back up so now we already have
multiple reversal signals first we saw a brick of a trendline which means the
price broke the uptrend structure and a double top pattern indicating a loss of
upwards momentum because buyers fail to push the price back up so all these
factors combined have led us to believe that the trend is going to reverse and
so this is a good opportunity to take a short position and of course no
strategy is 100 accurate so we need to make sure that our exit strategy is in a place so for our stop loss we can place it near a key level which is slightly
above the double top pattern and set your profit target at 2 1 risk ratio and
as you can see this trade ended up being profitable now
let's look at other variations of this technique so in this
chart we spotted a clear uptrend as price is forming higher highs and below it
we have multiple rejections meaning we can place an upwards trend line next we
can see the price failed to make higher highs and formed a lower highs instead
while also breaking the upwards trend line so this indicates that the upwards
buying pressure is weakening and that sellers are starting to push back but
again don't take any positions yet because remember the overall trend is still
an uptrend so we still need further confirmation next we can see that the price
tried pushing back up and failed now notice what the price is currently forming
it formed lower highs and lower lows which means we now have a current
downtrend so
let's recap what we have currently first we have momentum
loss indicated by the price failing to form higher highs then we have a
trendline breakout indicating that the uptrend structure was broken and finally
we have a current downtrend because prices forming lower highs and lower lows
so all these factors combined has confirmed that the trend has shifted to
the downside and so this is a good opportunity to enter a short position and
for your exit strategy, you can place your stop loss at the nearest key level
and set your profit target at 2 1 risk ratio and as you can see this ends up
being another profitable trade now what I just showed you is how we spot
reversals if the price were to break out of a key level but remember prices
don't move like this every time there are also scenarios where the price
bounces off the key level instead which brings us to the second technique to
spot reversals
which is using key levels and this is how it works the first
step is we want to find a key level for the price to bounce off and in this
case we actually spotted a resistance level up here because the price went up hit
and reversed from it now the next step is we want to wait for the price to
approach that key level once again and as you can see we saw an uptrend
approaching the resistance level but remember you cannot just assume that a
reversal will happen just because the price hits a key level because price can
always break right through so we need to have extra confirmation to make sure
that the price will actually reject this key level and we can do that by
looking for overbought and oversold levels with the help of the stochastic
indicator so first go to the indicator section type in stochastics and apply it
onto your chart for the settings i like to leave it as it is and just use the
default settings
so for this setup what we want to look for is price touching
the key level while the stochastic is displaying overbought or oversold like in
this example right here but again prices can still break right through even
though the stochastic is that overbought so to confirm that there's actual
downwards momentum at this area you want to wait for the sarcastic to cross
below the overbought lines again and once this happens you can take a short
position and just in case the trade fails we need to have our exit strategy
ready so for our stop loss we can place it slightly above the key level and set
your profit target at 2 times the risk and as you can see this trade ended up
being profitable now moving on to the third strategy for spotting reversals
which is by using trend indicators like the exponential moving average and this
is how it works so first go to the indicator section type in exponential moving
average and apply two of it onto your charts and for the settings set the first
one by 10 and the second one by 20.
so now you have two ema applied and the way we read this
indicator is very simple if the line crosses above it indicate that the market
is uptrending and if the line crosses below it indicates that the market is
downtrend however for this version of the strategy we don't immediately take
positions just because the ema crosses over because if the market is unarranged
like this, it will actually give you many false signals so instead you want to
use this indicator as a secondary tool to confirm a reversal and this is how
you do it so again the first step is you want to find a key level for the price
to bounce off and we actually spotted a resistance level up here as price goes
up hit and reverse downwards next you want to wait for the price to approach
the same key levels again and once the price approached it you use the ema to
confirm the trend change in this area by waiting for the lines to cross over
downwards and once this happens you can take a short position now for your exit
strategy you can place your stop loss right where the ema crosses over and set
your profit target at 2 1 risk ratio and as you can see this ends up being
another profitable trade so those are all the different strategies that you can
use to spot reversals using this technique.