Reversal Trading – Forex Academy

Hundreds and hundreds of trading tools make it super easy for the traders to trade the markets. There are candlestick patterns, indicators, price action trading. All of these things making trading are an easy game for the traders. In this article, we are using the reversal patterns and double moving average to successfully trade the counter trend situations. Below is the explanation of a couple of reversals candlesticks and the double moving average.

BULLISH ENGULFING PATTERN

Bullish engulfing is a reversal pattern that appears at the end of the downtrend. The pattern consists of two candles, Red and Green. The first candle is red, which indicates the sellers are in control and the second candle completely engulfs the first candle, which shows that the buyers overtake the sellers.

HAMMER

Hammer is a single candle reversal pattern, and it appears in a downtrend. The pattern forms a hammer-shaped candlestick, where the lower shadow is twice as big the size of the real body of the pattern. The boy of the candlestick represents the closing and opening price, and the lower shadow indicates the low of the candle.

MORNING STAR

Morning star is a reversal three candle pattern appears in a downtrend. The first candle is red indicating the downtrend and the second candle opens gap down which means the sellers are in control and the third candle pushes the prices and closed near the opening of the first candle indicating the buyers stepping in and get ready for the brand new higher high.

DRAGONFLY PATTERN

Dragonfly is a single candle pattern which shows the extreme strength of the buyers. The candle open, close and high is the same, indicating the buyers are ready for the brand new higher high. It has a long lower shadow with no upper body.

MOVING AVERAGES

Moving average is a trend following lagging indicator based on the past price. The indicator is used for identifying market trends. If it is pointing upward and below the price, it means the trend is up, and if it is above the price and pointing downward, it means the trend is down. All the type of traders uses moving averages, and there are infinite numbers of averages exists, which traders used according to the market circumstances. If you are a lower timeframe trader, then use the lower averages and if you are trading the higher timeframe or swing trader, then go for the bigger averages.

REVERSAL TRADING STRATEGIES

The image below represents the Bullish engulfing pattern in the EURCAD forex pair.

The image below represents the buying entry after the short term reversal in the EURCAD. When the second green candle completely engulfs the first red candle and closes above both of the moving averages, it was an indication to go long. We took the entry after the pattern completion and choose to go for a brand new higher high with stops below the entry.

TRADING THE HAMMER PATTERN

The image below represents the Hammer pattern in the EURCAD forex pair.

The image below represents the hammer pattern and our buying entry in the EURCAD as you can see the price action prints the hammer pattern, but it failed to go above the moving average. At this stage, some trader chooses not to trade the pattern just because half of the criteria aren’t met. This happened some tie in the market where one tool is saying something and another one is saying something. In these situations, it is advisable to have enough patience and let the second trading tool to align with the first one. In our trade after the three hours prices goes above the moving average, which indicated the buying momentum is back into the show. With the stops just below the pattern, we choose to milk the trend for the brand new higher high.

TRADING THE MORNING STAR PATTERN

The image below represents the Morning star pattern in the EURCHF forex pair.

The image below represents our entry, exit, and stop-loss in the EURCHF forex pair. The market was in a downtrend, and when the prices prints the morning star pattern and both of the moving averages goes above the price, it means the market is printed at the bottom, and going long will be beneficial. We activated the buying entry after the pattern completion with the stops just below the entry, and for taking profit, the brand new higher high was a good area.

DRAGONFLY PATTERN

The image below represents the buying trade in the EURUSD forex pair.

As you can see in an ongoing downtrend when the market printed the dragonfly pattern, but it was below the moving average, which means we need to wait for another signal to line up to take the trade. Patience matters, if you take trade by having only one signal, then the chances of loss are very high. So wait let the things to settle, let both of the tools to align in one direction then only go. On this 15 minute chart when the moving average goes above the price action, we choose to go long with the stops below the entry.

CONCLUSION

In today’s world, we have a lot of tools which makes trading is an easy game. Do not try to use all the trading tools; instead, choose the one or two and master them on demo first then only choose another one. Here in this article, we discussed the four well-known candlestick patterns to trade the reversals. By pairing them with the moving average traders can time the market well. In these four trading strategies, two of them gave use the trades immediately, and two of them took some time to confirm the entry. Never be in a hurry to pull the trigger; it can produce disastrous effects. The major problem with the traders is that they always try to tell the market what to do next; instead, it is the market duty to tell us what to do next in the game, when to pull the trigger and when not.

While reversals are deemed to be extremely useful in some other forms of trading, some successful forex traders go as far as to say that they could prevent you from becoming a professional in this market. Whether you have vast experience dealing with fiat or you have yet to get to that level in your trading, you probably understand how crucial having a stable foundation for your trading career is. On one of the key topics for thinking and development in this respect includes the question of what forex is essentially about – reversals or trends. Even if you feel that you already know the answer, you may find some new perspectives and information in today’s discussion, which can help you become a better trader earning a greater profit more quickly. There are essentially two ways to do trade with one being easy and the other one difficult, and today you can learn why this topic is believed to be so vitally important for everyone wishing to reach the pro level.

A number of individuals trying their luck in this market believe that trading reveals is the right approach to discovering lucrative opportunities. Nevertheless, the answer to the question of whether you should be doing reversal trading or trend trading is considered to be the exact opposite of what the majority of forex traders generally do. Most traders, who are either at the beginning of their trading careers or moving from another market to forex, typically rely on the buy low, sell high method, placing their focus on tops and bottoms. This tactic may have even lead to some profitable investments, making you feel that you are on the right track.

Naturally, the odds of choosing the bottom in this thriving market are stacked against anyone attempting to grow their trading strategy based on this approach, which is why, despite some beginner’s luck, it can be severely detrimental to traders from the long-term standpoint. What this essentially means is that one lucky win can instill flawed thinking which can make you put all your eggs in one very unstable basket, waiting on that second win like a slot-machine player hopes for the next winning combination. This can inevitably make you lose focus of your trading account, which can ultimately lead to three most probable scenarios – you can either reach your break-even point, barely earn some profit, or most likely experience a complete downfall at the end of the year.

The reason why so many traders seem to fail at forex trading often lies in the fact that they misinterpret currencies as stocks, commodities, or equities that, unlike fiat currencies, actually have real values. When you think of stocks, you naturally think of assets, balance sheets, and products, which all play a part in determining a stock’s price. Due to a large amount of downright inaccurate and misleading information, terms such as overbought and oversold are frequently incorporated in trading in the forex market while, in reality, they have little to do with currencies. Currencies are simply not affected by the factors which may be relevant for other markets as they are directly influenced by the big banks, which can alter the price whenever and however they want.

The greatest actors, which are nowadays considered to be Citibank, Deutsche Bank, Chase Bank, and HSBC, have the ability to control and move the prices up and down, which only supports the statements provided above. Even with big news events, it is always the big banks that have a final say on the direction and time of every price change, further highlighting the insignificance of individual impact. Interestingly enough, if we look at the comparison between the stock and the spot markets, we can conclude that a large money influx will always determine where the stock prices will go, while the opposite is true for currencies. The big banks have a vast array of information at their disposal, which helps them assess where the money is concentrated and how it should be directed. More often than not, to act in their best interest, these major players decide to take the price the opposite way. What this implies is that the money they take is redistributed into the market, which is essentially how prices go up and down in this market.

While reversal trading is not what most professional traders would recommend doing, it is what allows big banks to manipulate the prices. In reality, whenever there is a currency pair that has been trending down long, it naturally implies that quite a few reversal traders never ceased trying to call reversals all the way down. Interestingly enough, the reversals will not occur until the moment every reversal trader decides to stop. To put theory into practice, we are going to use an example of the USD/JPY pair which really happened a few years ago.

As you can see from the image above, this currency pair experienced quite a long downtrend only to go right back up, which only happened because the money kept going in the opposite direction. The traders in this case would not stop picking the bottoms, which basically left room for banks to keep bringing the price down. To provide additional proof for this statement, we are going to use the sentiment indication available at dailyfx.com, which can help us see the balance of short and long positions of all the traders for the particular asset.

The blue line in the chart stands for all (reversal) traders, whereas the price exemplifies where the money went in reality. As the task the big banks have is to grasp where the money is headed and whether those positions are long or short on any currency pair, we can see at the very onset of this chart how the traders tried to go long when the banks recognized this tendency and decided to go short. However this did not stop traders from attempting to do reversals and they kept going long, and the discrepancy between these traders’ activity and the money’s actual direction is clearly demonstrated by the divergence of the two lines in the chart above. Going further along the chart, we can see how these price whipsaws all the way, which only proves how banks carefully follow each step traders take and do exactly the opposite.

Reversal traders are always on the loss because their money is constantly exploited due to their lack of knowledge or understanding of how trends function. There will always be a vast number of individuals trying to pick tops and bottoms who will actually help the banks secure themselves better. Of course, they will be allowed to have their single occasional wins so as to keep investing more, but these traders will always be losing more and more money because this approach is simply not sustainable and it does not benefit anyone but the big banks. You may try to rely on some indicators, such as Stochastics, RSI, Bollinger Bands, or CCI, hoping that this will help you win the game.

Unfortunately, you will find that even the best reversal tools available at the moment will only do you a disservice as the house always wins. Therefore, in order to make consistent money, you should invest in understanding trends and learning how to interpret market activity. By relying on trends, not reversals, you can actually secure a much more stable profit and save yourself from being another pawn in the big banks’ game, which should altogether be the best motivation for anyone wishing to trade in the forex market.