“Trend is your friend,” Jesse Livermore said.
The biggest trader of his time encouraged his peers to keep trading simply by following trends. You’ve probably followed his advice at some point, too. But what if the trend no longer wants to be your friend and reverses in the wrong direction? In this article, we discuss trend reversals, trend reversal patterns and how they can be an opportunity to profit.
Contents:
- Trend reversals: Pullbacks or corrections?
- Pullbacks
- Corrections
- How to make profit on trend reversals and avoid potential loss
- Moving forward
Interact with the underlined words and green dots to get additional details and explanations.
Trend reversals: Pullbacks or corrections?
Some of us have anxiously watched a trend reversal take place, worrying about potential losses because we didn’t think it would happen. Nevertheless, a trend reversal is a cold, hard fact of financial markets. It can happen at any time as the price of an asset changes its course or direction. For an asset that is typically on an uptrend, a trend reversal means a constant price decline and vice versa. Prices constantly go up and down during the trading day with varying levels of volatility, but it doesn’t always lead to an asset’s trend shifting. So, how can we be sure that a change of price direction is just temporary?
Pullbacks
A trend reversal can happen at any time, but one unmistakeable trigger is the news. For example, an asset can move downward for about an hour as a result of a news release before it retraces to its previous level. Experts call such movements “pullbacks.” A market drop of up to 10% is considered a pullback if it happens in a brief period of time. In other words, pullbacks are the result of a short-lived trend reversal.
On Sept. 1, 2022, the Brent price dropped as China enforced new COVID-19 lockdown measures, which added to investors’ wariness about high inflation and interest rate hikes. On a one-hour Brent chart with a simple moving average of 20, one of the reversal trend patterns — a shooting star — appeared as attempts to push the price higher failed.
The shooting star pattern indicates that the market will likely move to the downside. Highlighted above, the pattern looks like a hammer turned upside down, as the candlestick’s body has a long tail. As we can see here, Brent dropped to $93.653 when the reversal trend pattern appeared on the chart. By the time of writing, the price rose to $94.536, meaning the trend has not changed even though the price has shifted.
Corrections
There are some contradicting opinions about whether a price correction is another term for a pullback or if it refers to something else. Our experts believe that a correction is the next degree of trend reversal severity and can last long after a pullback. Although a price correction starts with a pullback, not all pullbacks lead to corrections. The depth of a correction may reach 10% to 20% above or below the current price, and could last as long as four months.
Two fatal 737 MAX Boeing crashes in 2018 and 2019, followed by the company’s planes being temporarily suspended in many international airspaces as well as the pandemic’s devastating effect on the air travel sector all dragged Boeing’s stock price further down over the past couple of years. As travel reopened in early 2022, however, the aerospace company’s stock price saw a surge, which jumped even higher after its second-quarter report was published in July 2022. This trend reversal was preceded by a hammer pattern in the chart.
On a one-day Boeing graph with an SMA 20 indicator, we can see that the trend reversal pattern appeared on July 7, 2022. The hammer’s long tail represents bears' failed attempt to push the price lower, which was overwhelmed by a stronger move to the upside following the initial drop in price.. In Fig. 2., Boeing’s price was $139.04 when the hammer appeared and rose to $144.60 shortly after. The trend was bullish for Boeing until mid-August.
How to profit on trend reversals and avoid potential loss
Learning will set you free. Reading our blog will free your mind from overthinking about future losses, as you’ll be able to pinpoint the fundamental reasons behind any trend reversal. This way, you won’t get a heart attack when a trend suddenly reverses against your current trade. Keeping an eye on Olymp Trade’s Insights section will help you quickly catch any trend reversal as or before it happens.
When a trend reversal is getting closer, we recommend trading on FTT mode with shorter trading durations so it’s easier to make a profit along the price’s peaks and dips. If you prefer trading reversals on Forex mode, then Pending Orders will come in handy. The abundance of Olymp Trade’s indicators and oscillators will help you predict at what time or price the current trend will reverse, so you can set the correct parameters to execute a profitable deal. Just remember that no single indicator or oscillator should be relied on completely to make trading decisions. RSI, Stochastic RSI, Bollinger Bands, MACD, and Fibonacci are popular indicators and oscillators for observing trend reversals. We chose SMA for our examples here due to its simplicity.
For trading on trend reversal patterns, a careful mind is needed, as we never know whether a trend reversal is just a pullback or a correction. So, we suggest opening a few trades in a shorter duration to seize profit and simultaneously avoid excess market uncertainty.
Moving forward
Stock market declines bring headaches to some traders, while others see it as the right moment to buy assets at a relatively low price. With Olymp Trade, you can trade wherever the trend goes as you step into Fixed Time or Forex modes. That’s why there’s nothing to be afraid of when markets go awry, because even a contradicting move like a trend reversal could be a money-making opportunity. That being said, though, we recommend becoming more acquainted with trendline-based trading strategies and testing out those strategies on a Demo account.
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Trade on Trend ReversalsRisk warning: The contents of this article do not constitute investment advice, and you bear sole responsibility for your trading activity and/or trading results.
