Reversal trading is a popular forex strategy that, when executed in the right way, can lead to the potential of major profits. But how and why does this advanced strategy work? Today, we’re delving deeper into the benefits of reversal trading, demonstrating how you can incorporate this trading technique into your forex arsenal.
So, what is reversal trading?
In the simplest terms, reversal trades are setups that reverse (hence the name) the market direction of any given currency. Taking advantage of opportunistic market entry, a reversal trade opens a position with a profitable valuation increase, reaping the benefits and then selling upon the expectation of a valuation fall.
Sounds easy enough…
Well, not exactly. Although this may seem like a relatively simple online trading strategy, accurately predicting and timing market redirection is no easy feat.
Studying forex signals and indicators is always a good place to start – keep an eye out for prices falling from a pre-established high in a bullish market or, alternatively, prices rising from a low in a bearish market.
It’s easy to identify these movements after they happen, but identifying these reversals before they develop is where you could make a profit. As such, keep the following at the forefront of your observations while checking in on your forex indicators and forex charts:
- Uptrend – Uptrend is identified as a consistent set of uncharacteristically high highs and higher lows. When this occurs, the market eventually reaches an ‘absolute high’, marking a reversal following the subsequent refirection of the market on a downward trend
- Downtrend – On the other hand, downtrend is identified as a recurring series of lower highs and lows, leading to the eventual ‘absolute low’ price valuation upon the market reaching rock bottom. When this occurs, a reversal subsequently takes place, in which an upward trending price action becomes evident
Commonly, these occurrences are a result of a convergence of both technical and fundamental factors, as opposed to a single influencing event.
Is it worth the risk?
Reversal trading is essentially a counter-trend method which, by its very nature, carries substantial risk. A reversal trader is entering the market against market momentum, opening up the possibility for substantial drawdowns.
This strategy can, however, be incredibly effective when executed perfectly – essentially, it’s all about timing. When considering a reversal trade, it’s important to keep the following at the forefront of your reasoning:
- Trade selection – The accelerants of market reversal simply must be evident when considering placing a reversal trade. A mixture of technicals and fundamentals is often the contributing force to this, so keeping one eye on the market at all times is essential to your trade timing
- Risk/reward – The consideration of risk/reward should never be far from your mind when online trading. Because of the risky nature of reversal trading, this is more important here than ever – so be sure to always analyse the balance of risk and reward with impartial logic and reason
As the most liquid market in the world, the forex market experiences high levels of speed and velocity. Reversal trading subsequently carries high levels of risk, with losses being far from uncommon when trades aren’t timed correctly. As a result, ensure you know what to look for and where to find it by obtaining all the fundamental knowledge of the market from our free industry seminar – you can sign up here.