How to Spot a Reversal Trade
Since my method concentrates mainly on trading reversals you will need to understand the mechanics of a reversal. So I am going to dissect a reversal trade and show you exactly how reversals form and why. There are three parts to a reversal:
Simply put, a preceding trend is a strong move by the Bulls or Bears indicating a lot of buying or selling pressure.
In the example above, the preceding trend is a very strong bearish move, indicating that there are a lot of Sellers in the market and very few Buyers.
You may be thinking ‘why is a preceding trend an essential part of a reversal?’ Well the answer is very simple. If an Indecision Candle forms without a preceding trend what the heck could it possibly be reversing from?
If it is not reversing from anything it cannot be considered a reversal candle!
In the image below you can see a bearish preceding trend. On the scales, you can see the Bears have a lot of power (9) while the Bulls have very little power (1).
When the Bears have a lot of power, they are in control of price…
Look at that. We have an Indecision Candle forming in the middle of a strong bearish trend. Think about what happened here for a second. In the picture above, you see that there was a lot of selling pressure and the Bears had control. All of a sudden, you get this Indecision Candle.
An Indecision Candle means that the Bulls and Bears now have equal power. In other words, it means some Sellers have left the market and some Buyers are entering into the market. This transition of power is reflected by the Indecision Candle.
There are many different types of Indecision Candle. The strongest by far is the Long Wicked Pattern I showed you on the candlestick analysis page.
The Reversal Trend
The reversal trend occurs when Buyers flood the market and selling pressure decreases. So now you have a Bull controlled market and it begins to move up. A trade is entered somewhere in the bullish trend.
Here a reversal trade broken down into its three parts: