Below, we have also added the approximate area of your take profit order during a trade. Again, this level is calculated using the measured move technique described earlier. You now have all the relevant trading levels for the reversal chart pattern. The reason for this is that oscillators can help signal extreme values, which can provide confirmation of trend reversals. The idea is to match a reversal signal from the reversal setup with a reversal signal from an oscillator indicator.
Click Here To Join If we have a bullish trend and the chart is forming a potential reversal pattern, we will be looking for an overbought signal from the RSI. This way we will attain a stronger reversal signal, which is likely to bring a higher success rate for our pattern. Contrary to this, if the trend is bearish and we spot a reversal pattern, then we will try to match this signal with an oversold indication from the RSI.
Another signal from the RSI that we can take is the regular divergence signal. Matching signals with RSI divergences will give us a higher probability trade on the reversal pattern. After all, the knowledge of another chart pattern emerging can always come in handy. At the bottom of the chart, you see the RSI indicator.
The black dots show the Pivot Points of our chart pattern. Also take note of the formations outlined in blue on the chart. They represent some other chart patterns that we will use during our trade analysis. Here is what happens: We spot a bearish trend on the chart blue bearish line. At the beginning, it might be hard to spot the first two Pivot Points on the chart. However, when the price closes a higher bottom at Pivot Point 3 and then closes a candle above the blue bearish trend line, this triggers some bullish thoughts.
At the same time, the first rectangle on the RSI indicator shows an oversold market condition. Then, suddenly, we see that the price breaks the trigger line of the chart pattern, which we could take as a long signal. We place a stop loss order below Pivot Point 3 and a take profit order at a distance equal to the size of the pattern pink arrows.
Instead, we see a correction with the shape of a Flag chart pattern blue bearish channel. Notice that the stop loss order is still intact. Later on, the price breaks the flag in the bullish direction and hits our take profit line. If you are not trading with a take profit order and relying on price action alone for collecting your profit, here is how you may have analyzed the price action. The price continues into another correction that is horizontal and then shoots up again.
At the same time, the RSI gives a strong overbought signal. The market starts consolidating and we see a candle closing below the lower level of that consolidation. This is a strong signal for closing the trade here. If you closed the trade at the target line, this would have equaled a profit of around 45 pips.
The interesting thing about this trading example is that the reversal chart pattern acts as a double bottom. And we trade it very similarly to a double bottom chart pattern. The Pattern Setup as a Continuation Although we are approaching the chart setup as a reversal, it could also act as a continuation pattern. In other words, it could give us a signal that the trend is not reversing. Instead, we might be looking at a flatter correction, which could trigger a new move in the same direction.
After the pattern forms Pivot Point 3, changing the direction of the price, there are two cases, which we need to consider: Case 1 — Potential Trend Reversal This is what we already discussed — the pattern as a reversal. The price can break the level at Pivot Point 2, confirming a potential reversal. This will trigger our reversal trade. Case 2 — Potential Trend Continuation This is another consideration.
If the price fails to break the level at Pivot Point 2, or breaks it slightly and then reverses quickly, then this was most likely a flatter correction. The breakout in Pivot Point 3 will give us a signal that the trend is resuming. In this case you should consider trading in the direction of the previous trend.
The vertical distance between Line 2 and the midpoint of Line 1 will give you the size of the pattern. However, since the pattern confirmed a continuation, we need to apply its size in the direction of the continuation. You should take Pivot Point 3 as a starting point of your target. In many cases, the continuation version of the chart pattern will have the characteristics of a wedge , a flag or a triangle.
Again, we have the RSI indicator at the bottom of the chart. We have a bearish trend at the beginning of the chart. Then, the price starts consolidating. We confirm the presence of Pivot Points 1, 2, and 3. However, this time the price fails to break the resistance at Pivot Point 2, turns around and breaks the level at Pivot Point 3. In this scenario, we suspect that the trading pattern is very likely to act as a continuation here, and not as a reversal.
At the same time, the RSI indicator gave us an overbought signal, which confirmed the bearish idea on the chart. This is a good opportunity to sell. The stop loss order should go above the level of Pivot Point 2. We should apply the target downward, starting from the confirmation level at Pivot Point 3. We do this by measuring the size of the pattern and applying it starting from the confirmation level as shown with the pink arrows. After the confirmation signal, the price creates a correction and turns the support at Pivot Points 1 and 3 into a resistance, which gives an even stronger short signal.
At the time when the target is met, the RSI indicator is giving an oversold signal, which is a good reason to close the trade. The trader will be able to make this choice by trading the pattern again and again. Let us understand the step by step process of the strategy.
In this example, we are applying our strategy on the 15 minutes time frame and during one of the major trading sessions. Step 1 The first step of the strategy is to look for point 1, which is essentially the highest point of a trend. In our example, we can see that the previous lows have been tested multiple times, and thus we have chosen the highest point as our point number 1. Step 2 The next step is to mark the point number 2. When the market pulls back to the recent support or resistance area after reacting from point 1, we mark this as point 2.
Remember that the price should not only reach that area but also react and move higher for uptrend or lower for downtrend. This confirms the key technical level. Step 3 The formation of the pattern is complete after identifying the third point. When the market moves in the area between points 1 and 2 and later comes goes back to point 1, the point from where the market reversed becomes our point 3. The first one is an aggressive way to take an entry on a break of point 2, and as the market starts moving in that direction.
This gives additional confirmation that the market is ready to go in a favorable direction. In this case, we have entered the market right after point 2 is broken, which is a little aggressive. Step 5 Finally, we need to determine our stop-loss and take-profit levels for the strategy.
The take-profit is placed at a point where the resultant risk to reward is at least However, if there is a hurdle in between, profits can also be taken at such points. Strategy Roundup The pattern is a major trend reversal pattern is one of the best strategies for trend reversals. One can trade using this strategy on any time frame. The strategy is based on the idea that the market is losing momentum in the direction of the major trend and could reverse any moment.
The probability of this strategy is high and does not require knowledge of technical indicators.
After the high point, your next job is to look for a pull-back. It can happen on the same candle, but I prefer to see it on subsequent candles. It just looks better to me that way. If it appears to be happening on the same candle, drop down to the next lower time frame and see how it looks down there. This will be the number 2 point of your Read more about Candlestick Charts here. If the next high exceeds the point 1 high, then your high is blown and you can move on and look elsewhere. To the left you will see what was a potential high that is about to be blown.
This was looking like a pretty nice 1 2 3 trading strategy pattern until the last few minutes when it started to test the number 1 high. Officially, your trade entry is a break of the number 2 point to the downside. Therefore, it requires you to trade with the smallest size. Why do Reversal occur? As I've said, charts reflect the emotions of traders.
Certain pattern strategies occur regularly on charts. We've all seen head and shoulders patterns , various triangle and flag patterns and the more complex harmonic patterns. The reasons these patterns continue to provide trading opportunities is that the emotions that caused these patterns are consistent and happen frequently.
The patterns don't always hold - sometimes they're affected by other factors like news - but they are consistent enough that we can use them to make profits in the market. The number 1 point occurs at a place where traders who were long in the market decide they need to secure the profits they made during the trend up.
That's why the initial trend is very important. It's also why you should watch for this point at a place of strong resistance. It's the place where traders will feel that the market may stall or turn. In other words, they fear they may lose the profits they've got in place. The surge in volume is due to the "not so smart" money finally recognizing the trend and jumping on the bandwagon euphoria - "this trend could last forever, I gotta get me some".
That surge in volume usually happens when a move has reached exhaustion. The volume is a signal that the smart money is passing on their holdings to the latecomers, leaving them "holding the bag". This is the number one point. Of course, after there are no more traders to buy up the positions the latecomers entered, the price starts to drop.
As the price drops, the smart money sees an opportunity to possibly make a little profit on another pop to the number 1 high, but they are less committed because most of the longer term momentum indicators are still giving overbought indications and the market has just made a big up move. Eventually, all the latecomers that bought while the market was at the peak are experiencing fear.
As the market continues to drop, they unload those positions to the smart money - who are more willing to buy as the price drops lower. Until there are no more folks wanting to sell. That's the number 2 point. Now that the latecomer sellers are gone, prices will start to move up again. The smart money folks bought from the latecomers, so now as it starts to go up again, the latecomers figure they got out too soon and start buying again, but since they were burned before, they are a little warier, so fewer of them get involved this time.
And of course, the smart money folks are more than willing to take their profits as the market goes up. But since there are fewer willing to buy this time, when the price peaks, it often doesn't get as high as the number one point before it starts dropping again. This is the number 3 point. As the market starts to drop from the number 3 point, the more educated, smart money traders recognize that this could be a reversal or the beginning of a trading range, but at the very least, they are willing to sell down to the number 2 point again - which is exactly what we will do.
This causes prices to drop back to the number 2 point - often breaching the number 2 point by a few pips. When do Reversals occur? As I mentioned before, reversals most often happen at areas of support and resistance. They happen after a good strong trend. They can happen at any time frame on any instrument. On the shorter time frames less than one hour , you have to watch continually or you will miss your opportunity.
Often you can see one after a big news event. That's why I prefer to trade hourly or higher. I day trade periodically and will watch the 5 minute and minute charts, but I have a short attention span, so I've got to be in the right frame of mind to do that.
I know folks that do it on the 1-minute charts and make lots of pips daily doing it. I just can't concentrate that much for that long. That's why trading is such a personal thing. You have to know your strengths and limitations to be a profitable trader. I tried to trade like someone else, but I couldn't be profitable that way. That's one of the things I learned early on from Winner's Edge. I didn't mean to digress into trader psychology, but in my opinion it's the most important factor in trading success, so I thought it warranted a few words.
How do I trade a Reversal? I use three different entries for the The first one is what I call "cheating the number 3 point". The second is trading the "standard" break of the number 2 point and the third is to trade the retracement after the break of the number 2 point. My favorite entry is cheating the number 3 point as this can be done with very little risk, fairly large trade size and works quite well. How do I determine position sizes? I'll go into more detail about entries below, but I'll take most of the first reversal position cheating the number 3 point off before the second entry point occurs.
Also, the first position, while having a low risk in terms of pips - also has a lower probability of success. Because of these factors, I usually use about half my standard trade size on the first position. I then use half on the second entry and half on the third entry. Calculate the number of pips for your stop loss on each position we'll talk about where to place stops a little later and use a risk calculator to determine your trade size.
Trading Strategy Guides has a risk calculator you can find here. Use it with our compliments. How do I enter and manage the positions? The first one I call "cheating the number 3 point". The completion of a number 3 point is the first indication that a reversal may be occurring. Officially, it's not a reversal until it breaks the number 2 point so that's why I call this entry a "cheat".
When I see the first two points and see price pop to the number 3 point and start to drop, I start anticipating the entry. As soon as price breaks below the highest candle at the number 3 point, I take a short entry with a stop loss just above the number 3 point. Trade Entries for the ugly High The second entry is the "standard" trade strategy for the reversal.
In fact, once you have a number 3 point, you can put a pending short a few pips below the number 2 point. How far below the number 2 depends upon the time frame you are trading. When trading the hourly time frame, I usually put the order 5 pips below the point. Be sure to make allowance for the spread. Since you're most likely looking at a Bid chart, then you won't have to take spread into account.
Lennox has been trading the S strategy for over a decade and recently applied these techniques to the Forex with spectacular success. Peter is the founder of Forexmentor. S helps Forex traders to locate, enter and exit trades across all timeframes.
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