This blog post was published on my blog earlier. Here is the reproduction of same.
Today I am trying to write something about trend reversal in very simple language. It is a very vast subject in technical analysis world and many traders have written about it. There is nothing new in this writeup. I have just presented it the way I think, the way I approach reversal while day trading.
We all know “the trend is your friend until the end when it bends” but we fail to remember it every time we take a trend reversal trade. It may happen because the trade looks very good and well poised for reversal at the extreme. Here I feel a trader should be cautious, because after the first move against the trend, the market actually continues to trend and attempts to test the old extreme level in the trend. We need to understand that a reversal during a trend may not necessarily be an actual reversal from a downtrend to uptrend or from an uptrend to downtrend, but it may stand for a transition between an uptrend or downtrend and a trading range, a transition between a trading range and an uptrend or downtrend, or a mere breach of a support/resistance.
What actually happens most of time is that after some kind of a good directional move, price will chop around and consolidate. We simply cannot expect another good move immediately. Usually, there will be a second leg or at least an attempt for a retest (second push). V shape reversals are rare. There will be a lot of pullbacks, chop, consolidation along the way in a strong trend, hence trading in the direction of the trend at the consolidation or range extreme is the only way to trade rather than looking for reversal. There will be even complex pullback so it is always better to wait for the same especially if there is a strong trend.
Remember, trends may last for longer than one would anticipate, most reversal setups fail and the majority of continuation setups succeed. This explains why traders need to use extra caution when trading against the trend, based on reversal setups.
Trend will ultimately reverse, no matter how strong the trend is. It simply cannot go on and on. There will be sometimes a sign of tiredness or exhaustion in the trend before the actual reversal in the trend. Sometimes it will reverse from the good demand/supply area. There can be any reason to trigger the reversal and once the reversal is confirmed, one can look to trade in the direction of the new trend.
Usage of Trend Reversal in Day-trading
For day-trading we need to constantly look for the trading opportunities and there will be a lot of reversal setups during the day which we cannot ignore. Here are the few specific setups for the so-called “reliable counter-trend trade.”
1) The only most reliable counter-trend entry is to trade counter-trend to a pullback (as the pullback represents a small trend in the opposite direction of the main trend). It may lead to at least a test of the extreme level in the main trend. Buying/selling at range low/high is what we need to look for constantly. Here the concept of TRAP setup comes into play and can prove to be a very good trade setup.
2) Pressure Play setup plus BOF of DP or range extreme is a deadly combination for a good reversal trade.
3) Orderly pullbacks in a trending move, stalling at a DP, retest, and towards the end of the day is another deadly combination of a good reversal trade. It is explained more in the example below.
It is always rewarding to trade in the direction of the trend. Hunting for the reversal setup majority of the time is not going to work especially if the trend is strong. Being very selective while approaching reversal, as illustrated above, will likely help staying with the trend till it bends.
I will try to write more about the reversal in day-trading context some other time. I hope you would find that interesting.