How to Identify Reversals
Properly distinguishing between retracements and reversals can reduce the number of losing trades and even set you up with some winning trades. Classifying a price movement as a retracement or a reversal is very important. It’s up there with paying taxes. *cough* There are several critical differences in distinguishing a temporary price change retracement from a long-term trend reversal.
A popular way to identify retracements is to use Fibonacci levels. Mostly, price retracements hang around the 38.2%, 50.0%, and 61.8% Fibonacci retracement levels before continuing the overall trend. If the price goes beyond these levels, it may signal that a reversal is happening. Notice how we didn’t say will. As you may have figured out by now, technical analysis isn’t an exact science, which means nothing certain, especially in forex markets.
Using pivot points is another way to see if the price is staging a reversal. In an UPTREND, traders will look at the lower support points (S1, S2, S3) and wait for them to break. Forex traders will look at the higher resistance points (R1, R2, R3) and wait for them to break in a DOWNTREND. If broken, a reversal could be in the making!
The last method is to use trend lines. A reversal may be in effect when a major trend line is broken. Using this technical tool in conjunction with candlestick chart patterns discussed earlier, a forex trader may get a high probability of a reversal. While these methods can identify reversals, they aren’t the only way. At the end of the day, nothing can substitute for practice and experience.
You don’t have to be shot down by the “Smooth Retracement.” You don’t have to lose all those pips. All you need is to know how to distinguish retracements from reversals.