Simple Price Action Technique to Spot a Trend Reversal

Every trader wants to ride a trend. The trend is your friend, right?

That’s true all the time. But, there’s a catch.

The Forex market doesn’t trend that much. I mean, it sure does, but what seems like a trend, turns out reversing when no one expects.

From a money management point of view, traders overcome a reversal by trailing the stop. However, this ends up exiting on the first swing against the primary trend.

Or, in a trend, there no such thing as a straight line. The market moves and corrects. After all, this is the very definition of a trend.

Namely, connecting two points. But, those points appear when the market corrects the primary trend.

Simple Way to Spot a Trend Reversal

How do traders know when a trend ends? Or, when a new one starts?

Typically, what traders do is to wait for the main trend line to break. While this is correct most of the times, it often gives false signals.

What if I told you there’s another, more exciting way, to look for a trend reversal, without even using a trend line? Here’s how.

Take Clues from the Previous Trend

Because the market moves in waves, the move of the primary trend gets to be corrected by smaller counter trend ones.

Effectively, this means that in a bearish trend, the moves in the main trend will make lower lows, while the counter-trend moves will make lower highs.

For as long as this series of lower lows and lower highs holds, the trend won’t reverse. No matter what fundamental analysis or some other kind of study points to the upside, the trend will keep going.

In a bullish market, the upside moves will see the price continually making higher highs. At the same time, the pullbacks won’t break the previous low.

That’s a bullish trend, and the market won’t reverse until the series of higher highs and higher lows ends. As such, the first clue that a trend will change is when the market breaks the previous trends last lower high or higher low.

Let’s look at the EURUSD recent daily chart. For the whole summer of 2017, it moved aggressively, in a bullish trend.

However, before that, traders could have spotted the previous trend’s reversal. Just use the same steps explained above, and you’ll end up with the chart below.

Trend Reversal

From left to right, the market formed a bearish trend. And, the most recent lower high held on the first bullish attempt.

However, the second attempt saw the EURUSD breaking the previous lower high. That’s bullish, as it signals a new trend started. Or, it shows the previous one ended.

As such, to respect the new higher lows and higher highs series that corresponds to a bullish trend, the previous higher low must hold.

How about a trade? When can traders go long?

For this, we need a trend line. Just connect the first two points of the new trend line, and when the price hits the line, that’s the perfect place to buy.

Price Action

Because the previous higher lows must hold, that’s the stop loss. As for the take profit, look for a risk-reward ratio that is bigger than 1:3.

Considering this is the daily time frame, this simple price action technique gave excellent results.

Conclusion

Technical analysis doesn’t have to be complicated. Traders often get lost in so many indicators and trading theories that they forgot the bread and butter of technical analysis: trend reversals and trend riding.

As always, price action comes to help. Only use the logic of lower lows and lower highs in a bearish trend, and higher highs and higher lows in a bullish one. You’ll be on the safe side of the market.

 

 

 

Morning and Evening Stars in Forex Trading

Technical analysis as we know it today changed dramatically. Personal computers are responsible for it.

However, some patterns stand the test of time. No matter the market and the changes in execution, some patterns survived. Japanese candlestick techniques are such patterns.

Before discussing one of the most popular Japanese patterns, it is worth mentioning that, mostly, they are reversal ones.

As such, they form at the end of a trend. Either a bullish or a bearish trend, at the end of it, the market will form some sort of a Japanese reversal.

The Japanese candlestick patterns are made of a single candle or a group of candles. Their power is proportional with the time frame they appear on.

Stars are powerful reversal patterns. The bigger the time frame they appear on, the more powerful the signal is.

Trading Forex with Morning and Evening Stars

A star is a group of three candles. The name of the star comes from its implied future direction.

Having said that, a morning star is a bullish pattern. Hence, it forms at the end of a bearish trend. Remember? It shows a reversal.

On the other hand, an evening star is a bearish pattern. It appears at the end of a bullish trend and shows weakness.

However, both morning and evening stars will have a difficult time to reverse a trend. Typically, after a Japanese reversal, the ones that trade in the direction of the underlying trend will try to take the highs (in an evening star) or the lows (in a morning one).

This happens from time to time. But it doesn’t mean traders should disregard the patterns.

The secret is to integrate the morning and evening stars trading with a proper risk-reward ratio. It means at least 2 or 2.5 for every pip risked.

In doing that, discipline takes control over the trading process. As a result, Forex traders have more chances to survive in the long run.

How to Trade a Morning or an Evening Star

As mentioned earlier, the pattern has three candles. The first one is a strong candle in the direction of the original trend. It has a strong green body (in an evening star) or a strong red one (in a morning star) and a very short shadow.

The candle in the middle is either a hammer or a doji. In both cases, it shows reversal conditions. Or, at least hesitation.

The last candle moves in the opposite direction when compared to the original trend. It has a strong body, at least like the first candle has.

evening star

Above there’s an evening star that respects all the rules described. There’s a strong, bullish trend, and at the end of it, a group of three candles that form the evening star.

The market reaction speaks for itself. Unfortunately, look at the time frame. It is the hourly chart.

As such, chances for the pattern to survive are slim. Moreover, there’s no retracement after the third candle.

Typically, traders look for bulls to put up a stiff fight and retrace at least fifty percent of the pattern. That’s a great place to go short. However, this pattern here lacks that retracement.

Yet, the market retraced and, for the hourly time frame, it still offers a nice risk-reward ratio.

Conclusion

Japanese candlestick techniques are great reversal patterns. They work great, especially on the bigger time frames.

But the secret comes not from one’s ability to spot them. There are clear rules for that.

The key is to integrate the patterns in a strong money management system. That’s the only way to profitable Forex trading.