Catching a falling knife, standing in front of a speeding train, buy low and sell high, these are just a few of the terms used (some flattering, others not) to describe the art of trading reversals. If successfully identified and executed, it can be one of the most lucrative trades that exist. But the key is how to identify, with consistency, those areas where price action is likely to change course and present a reversal trade.
I am going to share with you the process we go through to identify those trades that have the best chances for success.
Step 1: Identify the Big Picture Trend
A question that we often get asked is “why are you trying to buy dips, when the market is clearly in a bear run?” This common question is often asked by a trader who is only utilizing a single time-frame to make a trading decision. Let me explain.
In the chart listed below, this market is in a classic bear trend; lower moves low and lower moves high.
Figure 1: 1-Minute CL Chart
However, what is missing in this chart is a bigger picture perspective to truly identify the higher time frame trend. What you can see in the chart listed below is really the 1-minute chart (shown above) is simply a smaller pullback in a higher time-frame bull move.
Figure 2 60-Minute CL Chart
So, in order to properly identify a reversal trade, it is important to identify the higher time frame trend in order to execute a proper reversal strategy. I am a day trader and as such, I don’t hold positions past the close each day. My “higher” time frame chart is going to be different than that of a swing trader or a buy and hold trader. Simply put, you will need to identify the type of trader that you are and apply the appropriate higher time frame chart. For me, the higher time frame is the daily chart.
In the chart example listed below, I am looking at a daily chart of the USDJPY currency pair.
Step 2: Utilize the MTB Pro Decision Point to find Support and Resistance
Once you have identified the direction of the market on your higher time frame, you then want to begin to identify possible areas of pullback on this higher time frame chart. The objective of this is to identify areas of possible reversal (trading opportunities) to get into sync with the trend.
As you can see there is a possible pullback area into the trendline that has been resistance to price advances in the recent past.
Additionally, you can use fib retracement levels to add confluence to your prediction of a possible reversal point. The standard 61.8% and 78.6% levels along with the non-traditional 70.5% (shown in red) in the chart below.
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