Select Page

Reversal

All trend reversals begin as a potential trend retracement. Remember, a trend retracement always precedes continuation of the predominant trend. However, a trend reversal never precedes the continuation of a trend. If a trend reverses, a new trend is instituted. An uptrend reversal consists of a subsequent downtrend. A downtrend reversal consists of a subsequent uptrend. An uptrend or downtrend converting to a sideways trend is not considered a reversal.

For an uptrend to reverse, buyers and sellers must exchange power; selling continuously exceeds buying. If selling pressure fails to continuously exceed buying pressure at lower and lower price levels, there can’t be a bearish reversal.

For a downtrend to reverse, buyers and sellers must exchange power; buying continuously exceeds selling. If buying pressure fails to continuously exceed selling pressure at higher and higher price levels, there can’t be a bullish reversal.

Generally, a reversal in market sentiment precedes a reversal in price.

An uptrend or downtrend converting to a sideways trend is considered a period of consolidation. When the phase of consolidation ends, the predominant trend should continue. If a phase of consolidation persists for a prolonged period, it is no longer considered consolidation. Instead, it is simply considered a sideways market. Many traders consider a “sideways market” and “consolidation” synonymous. It is important to keep the two distinct. 

The word “consolidation” implies that an occurring action or process makes something stronger. A secondary definition of the word consolidation implies that an action or process combines several things into a unified more effective whole. Therefore, consolidation should precede the continuation of the predominant trend. If a phase of consolidation precedes a trend reversal or prolonged sideways market, then we cannot logically consider the sequence of price movement to be consolidation. During a trend, if prices trade sideways for a transient period before continuing the trend, we should consider the sideways price movement as a phase of consolidation. During a trend, if prices stall and trade sideways for a prolonged period, we should not consider the price sequence as consolidation. Instead, we should interpret the price sequence as an extended period of indecision and equal force between bulls and bears. During a trend, if prices stall and subsequently reverse, we should not consider the sideways price sequence as consolidation. Instead, we should attribute the sideways price sequence as a reflection of trend exhaustion and weakness. As a result, the opposing force (bulls during a downtrend, bears during an uptrend) reclaimed control of the particular market. 

Let’s look at an example of a bearish reversal.

Figure 1.1 Bearish Reversal

A picture containing text, sky, outdoor

Description automatically generated (NYSE: M)

Figure 1.1 shows an uptrend converting to a downtrend; a bearish reversal. In real-time, the initially marked trough may be perceived as a bearish retracement. However, buyers did not regain control of the market intermediate to long-term. The particular market continued to decrease in price. We can identify the downtrend by analyzing descending peaks and troughs.

Later in the book, we will learn how to implement techniques, methods, and indicators to discern a trend reversal from a trend retracement. 

Figure 1.2 Bearish Retracement vs. Bearish Reversal

Timeline

Description automatically generated (NYSE: HD)

Figure 1.2 shows the variance between a bearish retracement and a bearish reversal.

Figure 1.3 Bullish Reversal

Graphical user interface, timeline

Description automatically generated (NYSE: YUM)

Figure 1.3 shows the variance between a bearish retracement and a bullish reversal. Notice how each bullish retracement precedes the continuation of the predominant downtrend. However, the bullish reversal constitutes a change in the predominant trend; bearish to bullish. 

We can use the retracement tool to distinguish a retracement from a reversal. It’s in our best interest to consider a prices move more than 66% against the predominant trend a reversal. A 33 – 66% price move against the trend is a retracement. A move less than 33% is a pullback. There isn’t a hard rule when it comes to classifying a price sequence as a reversal, retracement, or pullback. However, a pullback and retracement always precede continuation of the trend. A reversal constitutes a new trend entirely.

A trend reversal should leave no doubt as to whether the preceding trend has ended.

Novice analysts should refrain from trading a counter trend price move until they can definitively conclude the trend is over, a new trend has instituted, and that new trend is exploitable.

Try to objectify your trading! 

Join our Discord server! We will help you build a mechanical trading system and backtest it! We will send you the code; you can backtest the system on ANY stock at ANY time!

https://discord.gg/usksugbr2H

The servers getting a bit large.

Make sure to join before we are forced to close off access for a bit!

Courses Archive – Kioseff Trading

Check out our Youtube Channel for trading systems with code access! (You can backtest the systems at any time AND set alerts)

Kioseff Trading – YouTube

-Kioseff Trading 

Legal Disclaimer: The information contained in the article is not intended as, and shall not be understood or construed as, financial advice. The author is  not an attorney, accountant, or financial advisor, nor are they holding themselves out to be, and the information contained in this article is not a substitute for a professional who is aware of the circumstances and facts of your personal financial situation. 

The author does not have a position for the discussed securities and does not plan to open a position for the discussed securities. 

Losses can exceed investment. Any stock mentioned throughout the article does not constitute advice or a recommendation. Any losses incurred that are due to error, accident, malfunction, or any loss due to any reason is not the legal responsibility or fault of the author. 

The article reflects an expressed opinion from the author. 

© Kioseff Trading. All rights reserved. No portion of this article, or any content on the website, may be redistributed or passed as one’s own without express permission from the author.