One of the most valuable skills every forex trader should know is identifying a trend and price movement. The ability to identify trends positions traders for profitable gains as they become aware of the entry and exit points. A trend is an inclination of the prices to move in a specific direction over a certain period. It can be upwards, downwards, sideways, long term, or short term.
When the price moves in an upward direction, the market is bullish, therefore an uptrend. When it moves downwards, the market is bearish; therefore, a downtrend. A reversal occurs when the price trend changes from downtrend to uptrend or from uptrend to downtrend.
How to Identify a Trend Reversal
· Break of structure
The first clue that the market is about to reverse is when you get a break structure in the price movement pattern. For example, you have an uptrend, and then the market breaks down, pulls back, and then continues to go lower.
Whereas during the uptrend, you had higher highs and higher lows, you now get lower highs and lower lows against the existing trend after the pullback. Even though this is not a guarantee that the market is reversing, it is one of the clues of an impending trend reversal.
· Crossovers indicators
Many traders use indicator crossovers to monitor the trend movement and health, and it is easy to trace a reversal in them. The most popular crossover indicators are Parabolic SAR and moving averages. The first thing you will notice on the pattern is a break of the higher highs and higher lows in the bearish market and lower highs and lower lows in a bearish market.
If you sport a series of higher highs and higher lows, then that is a trend. When the pattern ends, the trend ends with it. You know you are likely to have a reversal trend when you are using two moving average crossovers. For example, if you are using a 20 and 50 EMA and one average crosses over the other, it could mean the trend is reversing, and you should be careful how you move on from there.
· Uncertainty in the market
Another indication that you might get a trend reversal is by an economic situation creating uncertainty in the currency market. For example, the situation could be due to an out-of-the-ordinary occurrence, a natural disaster, or a political upheaval. Such uncertainties could cause the price to trend in the opposite direction, and in many cases, they catch traders unawares.
· Reduction in the price volume and momentum
Momentum trading is vital to forex traders as it indicates when it is safe to buy or sell according to the price trend’s strengths. Momentum bases its concept on the price continuing to move in the same direction if the force behind the price move is enough.
Price volume becomes an essential factor to momentum traders because they become more aware of when to enter or exit positions depending on the number of buyers and sellers in the currency market. A reduction of buyers and sellers might indicate low volatility in the market due to a price trend reversal.
· Support and resistance levels reverse
Support and resistance levels are some of the most popular concepts with technical forex traders. Resistance is the highest point a price moves up before pulling back. Support is the lowest point the price reaches before it goes up again.
A resistance level indicates having a surplus of sellers, while a support level suggests an abundance of buyers. When the price breaks the support and resistance levels, there is a likelihood of trend reversal occurring.
· Time Frame Analysis
The likelihood of a decreasing trend continuation depending on the timeframe it takes to develop is another indication that you could be facing a trend reversal. For example, the trend move could occur too quickly, leading to a retracement or too slowly, leading to a range market environment or a trend reversal.
Wrapping it up
Identifying a trend reversal can be extremely tricky to many technical traders because it is not easy to pick the bottom of the market when the trading is down or select the top when the price is trading high. It is also challenging to know when the price will make a turnaround. However, there are clear telltale signs that tell you a market trend is reversing. Identifying when a trend reversal is most likely to occur allows you to know what to do to avoid any risks.