Trend reversals can bring some extremely fruitful trading opportunities, but they can also be dangerous if you don’t know how to trade the properly. Many traders will spend too much time and money guessing tops in the market and being proven wrong when their results could be turned around with a clear understanding of structure. So let’s have a look at trend reversals, how to identify them & how to trade them successfully.
Before we get into reversals it’s important that you understand the components of a valid trend. I covered all of this over in another article that you can find here. For a quick recap trends have four major components:
IMPULSE – A move in line with the overall trend
CORRECTION – A pullback move against the trend
HIGH – A high point formed at the end of an impulse
LOW – A low point formed at the end of a correction
To identify trend reversals we need to know how to find these components in a market and how to use them to spot shifts in the trend direction.
How to find reversals
Finding market reversals can actually be very straightforward if you know what to look for. Many people chase reversals by selling into the tops of trends hoping that it will reverse but there’s no real logic to this and ore often than not it leads to losing trades. I’m going to show you a simple effective way to identify and trade REAL trend reversals.
That simple & effective way is MARKET STRUCTURE.
Take a look at the diagram below. What we have here is an example of a trend reversal showing how the highs & lows of a trend react to each-other to form logical trend trading opportunity.
Notice how no reversal is present until the Higher Low in the uptrend is taken out by a Lower Low? That’s because until the structure breaks the market is still technically uptrending, so the only trading opportunities you should be seeing in a market that’s still making higher highs & lows are trend continuation trades.
SO for a valid bearish trend-reversal trade we need to see two things:
- Successful break of a trending structure low
- Successful formation of a trending lower high (after the break)
When these two things become present we then look to take our reversal trade from the newly formed ‘lower high’ to ride the new trend as far as we can until the market gives us reason to get out.
Bad reversal trades
Now let’s take a look at some BAD reversal trades. The kind of trades that you shouldn’t be taking. Understanding this is going to help you to avoid a lot of losses that you may have taken on badly planned and unconfirmed trades.
In the first example the trader was wrong from the get-go, no lower low came into the market so no reversal trade should veer have been attempted. The trader sold from a ‘lower high’ but the low was never taken first meaning the market is technically still in an uptrend. This is the most common reversal trading mistake and one that many traders make. it can be easily avoided by following the lessons I have taught you here.
The second scenario is a bit trickier. This trade looks at a scenario where a lower low does form, but the market still goes up! Not every market will be 100% accurate all of the time and sometimes you will see what appears to be a break in structure but actually ends up being a fake move. The problem here is not waiting for a lower high to confirm before entering the trade, so waiting for confirmation will help you avoid this issue. If however you use sell/buy orders to trigger your trades you are at greater risk of getting stopped out, but if you test these methods you will soon see that the wins will outweigh the losses regardless.
View the full video lesson
I have a full video lesson on trading trend reversals on my YouTube. Check it out!
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