How to Spot a Reversal Trade
You will need to
understand the mechanics of a reversal. So I am going to dissect a
reversal trade and show you exactly how reversals form and why. There
are three parts to a reversal:
Three Parts of a Reversal Trade
Preceding Trend
Simply put, a preceding trend is a strong move by the Bulls or Bears indicating a lot of buying or selling pressure.
In
the example above, the preceding trend is a very strong bearish move,
indicating that there are a lot of Sellers in the market and very few
Buyers.
You may be thinking ‘why is a preceding trend an essential
part of a reversal?’ Well the answer is very simple. If an Indecision
Candle forms without a preceding trend what the heck could it possibly
be reversing from?
If it is not reversing from anything it cannot be considered a reversal candle!
In
the image below you can see a bearish preceding trend. On the scales,
you can see the Bears have a lot of power (9) while the Bulls have very
little power (1).
When the Bears have a lot of power, they are in control of price…
Bearish Preceding Trend
Indecision Candle
Look
at that. We have an Indecision Candle forming in the middle of a strong
bearish trend. Think about what happened here for a second. In the
picture above, you see that there was a lot of selling pressure and the
Bears had control. All of a sudden, you get this Indecision Candle.
An
Indecision Candle means that the Bulls and Bears now have equal power.
In other words, it means some Sellers have left the market and some
Buyers are entering into the market. This transition of power is
reflected by the Indecision Candle.
There are many different types of Indecision Candle.
The Reversal Trend
The
reversal trend occurs when Buyers flood the market and selling pressure
decreases. So now you have a Bull controlled market and it begins to
move up. A trade is entered somewhere in the bullish trend.
Here a reversal trade broken down into its three parts:
Bearish Preceding Trend
Indecision Candle Forms
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