Trading Reversals

[Soultrader 12]

I would like to dedicate this thread to specifically reversals. I have been taught to build strategies around reversals in the futures market and momentum with stocks. Hence, will post some charts explaining setups and patterns that are common of reversals in global markets. Hopefully many of you can share your insights as well.

 

The first chart shows the KOSPI futures from today. A classic reversal patterns developed today with an obvious volume spike hinting first sign of accumulation/short covering. This is my first clue to watch for. The second clue is a lower low or test of low on diminishing volume. The third sign I prefer to watch for (not always as I may enter before this on an aggressive trade) is a break of a trendline. The fourth is a push through supply volume bar. Basically after absorption and climatic selling, I need an extra bar of professional buying which will force others to join and lift price higher. Higher prices will attract further buying as the late comers will climb on board.

 

 

More to come...

[firewalker 10]

  Soultrader said:

The third sign I prefer to watch for (not always as I may enter before this on an aggressive trade) is a break of a trendline. The fourth is a push through supply volume bar.

 

The problem with using the break of a trendline as a definite reversal signal, is that often a secondary one can be drawn, with a less steeper angle. I don't mean to say that there aren't profitable trades to be taken of this kind of move, but price doesn't have to reverse and can still continue after failing to retrace a decent part of the move.

 

I'll see if I can come up with a chart to explain what I mean.

[wasp 10]

Ahh, my forte... (sometimes!!)

 

Like any method you need strict rules to define what and when and I will contribute more over the weekend when I have more time but a quick chart of this week on the EURJPY that I have been watching. Coupled with S/R it can work well.

[Soultrader 12]

  firewalker said:

The problem with using the break of a trendline as a definite reversal signal, is that often a secondary one can be drawn, with a less steeper angle. I don't mean to say that there aren't profitable trades to be taken of this kind of move, but price doesn't have to reverse and can still continue after failing to retrace a decent part of the move.

 

I'll see if I can come up with a chart to explain what I mean.

 

Thanks fw, looking forward to it. Would like to learn more about ppls methods on reversals. On top of the chart explanations, I would like to add that I place great importance to where price is relative to previous day value area, previous day range, and control point.

[DbPhoenix 42]

  Soultrader said:

I would like to dedicate this thread to specifically reversals. I have been taught to build strategies around reversals in the futures market and momentum with stocks. Hence, will post some charts explaining setups and patterns that are common of reversals in global markets. Hopefully many of you can share your insights as well.

 

I used to attach a lot more importance to trendlines (or demand/supply lines) than I do now since so many good reversals occur before the trendline break. And if I wait for the break, the odds of a test that will take out my stop increase (unless I have a wide stop, which I avoid).

 

On the other hand, I've learned to attach far more importance to support and resistance. The "selling climax rally retest" pattern occurs in meaningless forms far too often, and one can easily end up making countertrend trades a habit (ditto with "hammers"). But if this occur at S/R, the odds of success increase dramatically. Yesterday, for example, the ES and NQ hit resistance almost to the tick, and the rest was just management. Without the test at that particular level, who knows?

[wasp 10]

  wasp said:

Ahh, my forte... (sometimes!!)

 

Like any method you need strict rules to define what and when and I will contribute more over the weekend when I have more time but a quick chart of this week on the EURJPY that I have been watching. Coupled with S/R it can work well.

 

  DbPhoenix said:

I used to attach a lot more importance to trendlines (or demand/supply lines) than I do now since so many good reversals occur before the trendline break. And if I wait for the break, the odds of a test that will take out my stop increase (unless I have a wide stop, which I avoid).

 

On the other hand, I've learned to attach far more importance to support and resistance. The "selling climax rally retest" pattern occurs in meaningless forms far too often, and one can easily end up making countertrend trades a habit (ditto with "hammers"). But if this occur at S/R, the odds of success increase dramatically. Yesterday, for example, the ES and NQ hit resistance almost to the tick, and the rest was just management. Without the test at that particular level, who knows?

 

Agree, the cross on its own is weak but when used/at areas of S/R the trade becomes much better.

 

Here is the same chart with the 240m and 60m levels on too. The reversal/crossover points become more valid and chances increase.

[DbPhoenix 42]

  DbPhoenix said:

I used to attach a lot more importance to trendlines (or demand/supply lines) than I do now since so many good reversals occur before the trendline break. And if I wait for the break, the odds of a test that will take out my stop increase (unless I have a wide stop, which I avoid).

 

On the other hand, I've learned to attach far more importance to support and resistance. The "selling climax rally retest" pattern occurs in meaningless forms far too often, and one can easily end up making countertrend trades a habit (ditto with "hammers"). But if this occur at S/R, the odds of success increase dramatically. Yesterday, for example, the ES and NQ hit resistance almost to the tick, and the rest was just management. Without the test at that particular level, who knows?

 

Here's one of the charts referred to above. Note that whether or not one considers the first bar to be "climactic", the volume on the test is considerably less. Resistance is at or about 1420.

 

[firewalker 10]

  DbPhoenix said:

Here's one of the charts referred to above. Note that whether or not one considers the first bar to be "climactic", the volume on the test is considerably less. Resistance is at or about 1420.

 

An very similar thing just happened on the NQ... (upper line = R, lower line = S, red dot = short entry).

 

[DbPhoenix 42]

This is a copy of a post I made to the original Wyckoff thread. I'm providing here partly because it's likely to be missed by newcomers, partly because it's pertinent, and partly because I spent so much time working on it.

 

Note here that when volume comes in at 0948, price is pulled down. But even though price continues its slide, volume breaks off dramatically, then works its way higher until 0952. All this appears to favor the short side. But look at effort and result. As volume rises, the bars get shorter, and when volume peaks at 0952, price closes well off the low, and buyers are able to push price higher in the next bar with much less effort; hence the lower volume. Therefore, throughout this "downmove", buyers are coming into the market, supporting the price, and even pushing price higher.

 

Volume then dries up considerably during the upswing after moving price to 1892. The big volume comes at 1000 and pulls price down almost to 1886. This appears, again, to support the short side, particularly since sellers are able to move price with little resistance from buyers (low volume, except for 1000).

 

Buyers and sellers then go back and forth, and volume does pick up during this exchange. However, the biggest volume is unable to pull price lower, and the end result is a draw. This is not good for the short side. At 1008, buyers are then able to push price higher with very little effort (again, low volume) suggesting that selling pressure is much less than it had been.

 

During the next segment, buyers are able to keep sellers at bay with relatively little effort (again, low volume). Next, buyers are able to push price all the way back above 1891, and though the volume is higher, suggesting that they had to work a little harder, it is not unusually high.

 

During the last segment, price drifts back a bit, but volume practically disappears, suggesting that sellers are done, and it's up to the buyers (note how easily buyers push price higher at 1019).

 

This is only about bars, however, if one can't see them move. If one watches them move in real time or via replay, he can detect the waves easily. Note here how price dips into each trough, then rises back out of it, crests, then repeats the cycle again and again, gathering strength along the way. If sellers had the upper hand, price would not repeatedly recover in this way.

 

 

Unlike my earlier post, this provides an example -- like James' example -- of a reversal that takes place off a lower low rather than a lower high.

[brownsfan019 17]

James - I'll say one thing - if looking at reversals, that's what candlesticks are built for. Could help compliment what you are doing to see what candlestick formation (if any) appears.

[DbPhoenix 42]

  DbPhoenix said:

 

Unlike my earlier post, this provides an example -- like James' example -- of a reversal that takes place off a lower low rather than a lower high.

 

Correction. "Lower high" should read "higher low".

[firewalker 10]

  Soultrader said:

Thanks fw, looking forward to it. Would like to learn more about ppls methods on reversals. On top of the chart explanations, I would like to add that I place great importance to where price is relative to previous day value area, previous day range, and control point.

 

I used to pay a lot of attention to the previous day highs and lows, as they seemed to "attract" a lot of trades. However, the best trades I got from these levels was when they coincided with some important S/R level. Sometimes I wasn't aware of these and it just looked as though the low or high from the previous day range "caused" a reversal. But thinking about it, why would price reverse just because of a number that doesn't mean much?

 

  DbPhoenix said:

I used to attach a lot more importance to trendlines (or demand/supply lines) than I do now since so many good reversals occur before the trendline break. And if I wait for the break, the odds of a test that will take out my stop increase (unless I have a wide stop, which I avoid).

 

I agree that waiting for a trendline to break will usually get you in late. However, "so many good reversals occur before the trendline break" seems a rather problematic description, if you define a trend reversal as Sperandeo does (for example). I don't mean to dwell on semantics, but - unless I'm mistaken in interpreting the above - you are suggesting that a reversal happens before the last swing low or high is broken... but isn't that by definition what constitutes a reversal in the first place?

[DbPhoenix 42]

  firewalker said:

 

I agree that waiting for a trendline to break will usually get you in late. However, "so many good reversals occur before the trendline break" seems a rather problematic description, if you define a trend reversal as Sperandeo does (for example). I don't mean to dwell on semantics, but - unless I'm mistaken in interpreting the above - you are suggesting that a reversal happens before the last swing low or high is broken... but isn't that by definition what constitutes a reversal in the first place?

 

Depends on how much confirmation one wants. Sperandeo's definition is perfectly serviceable, but it doesn't always result in a true reversal; price sometimes segues into a trading range or even makes another attempt at a higher high. However, for beginners who haven't the slightest idea how to define a reversal, it beats anything else I've seen.

 

I look for reversals as a part of testing support or resistance, including an exhaustion of effort. If I've interpreted it correctly, the TL is broken. And often the SP is broken as well (if it isn't, then I was wrong). But this requires a very small-interval chart unless one is willing to employ a pretty wide stop. And it's certainly not something I'd recommend to somebody who hasn't put in a lot of screen time.

[Soultrader 12]

ES chart from today.

 

[DbPhoenix 42]

  Soultrader said:

ES chart from today.

 

 

So does the circle indicate that you'd take the break of the TL or would you short the lower high?

[Soultrader 12]

  DbPhoenix said:

So does the circle indicate that you'd take the break of the TL or would you short the lower high?

 

1396ish where the previous day value low is. Would wait for a retracement back to it after the break of the trendline.

[firewalker 10]

  firewalker said:

The problem with using the break of a trendline as a definite reversal signal, is that often a secondary one can be drawn, with a less steeper angle. I don't mean to say that there aren't profitable trades to be taken of this kind of move, but price doesn't have to reverse and can still continue after failing to retrace a decent part of the move.

 

I'll see if I can come up with a chart to explain what I mean.

 

Alright, as promised... Took me a while to find a suitable example, but I think I have a good one here. 1-min chart of the NQ.

 

Top horizontal line = resistance (1732)

Bottom horizontal one = support (1705)

 

A trendline is drawn and later on in the day a new one, when another swing low is made. When price finds support around 1705, there is no lower low, near the right of the chart at "X" there's a first attempt to break higher, but if fails. Price comes back to support and there is another struggle, but after that we manage to pop up to 1710.

 

Would the first green dot be an entry signal? After that, price retraces, although it's more like a time retracement than a price retracement: very tiny bars and very tiny volume as well, almost complete dry-up. Do you wait for the second green dot? By then price is already 6 points higher than support though...

 

 

I've chosen this chart because, obviously, what happens next will not be what you want to see. But are there are "warning signals" here? Or do you just go along with what you see and pay attention if the equilibrium changes? After all, no one says you can't get out at breakeven...

 

So Soultrader, would you take this trade, or in what aspects is it different from the first chart you posted in this thread?

[Soultrader 12]

Couple differences in the trade setup is I would need to see the previous day value area. Also I cant read a 1 min chart so would prefer to take a setup based on a 5min. But would take this particular pattern:

 

 

 

It would help to know where price is relative to value area... past sessions profile pattern, and the level of support where price reversed to break the trendline.

[firewalker 10]

  Soultrader said:

Couple differences in the trade setup is I would need to see the previous day value area. Also I cant read a 1 min chart so would prefer to take a setup based on a 5min. But would take this particular pattern:

 

For the sake of the example, let's assume it's a 5 min chart...

 

  Soultrader said:

It would help to know where price is relative to value area... past sessions profile pattern, and the level of support where price reversed to break the trendline.

 

Here is a 2-day 5-min chart with candlesticks, without the overnight, up to the point I showed on the first chart. And another bar chart from the previous day, at your convenience

 

If you wish you can use the 5-min chart, any line that you would draw from the top of the second day would still be breached and it looks similar imo, so doesn't matter much.

 

 

[firewalker 10]

Btw, does NihabaAshi still post here, I seem to remember he was a clever guy over at ET...

 

Just found this related thread...

http://www.traderslaboratory.com/forums/f34/how-do-you-spot-reversals-893.html

[wrbtrader 10]

  firewalker said:

Btw, does NihabaAshi still post here, I seem to remember he was a clever guy over at ET...

 

Just found this related thread...

http://www.traderslaboratory.com/forums/f34/how-do-you-spot-reversals-893.html

 

Hi Firewalker,

 

I'm mainly a lurker here and I not clever nor do I try to out smart the markets.

 

I just try to understand what it is doing and that in itself helps with my confidence while trading.

 

Mark

[smwinc 20]

Nice idea for a thread.

 

Friday was a good example of a sell the open day. I put together 6 images of how I traded it, and how I came to my conclusions. I start with looking at Wednesday, then briefly how I traded Thursday, to give the reasoning for how I traded Friday.

 

Image 1 - Overview:

 

It's before Thursday's open, and we look at the previous days. The market is net selling, but we had evidence of failed buying - so we're stuck with some really pissed off longs. These guys probably know they are wrong by now, and need to get out for a scratch / small profit.

 

End result for Thursday: looking for a reversal up, before a reversal down (resuming the main "net selling" trend).

 

Image 2 - Morning:

 

Small gap up. I took the scalps labelled, fading the half gap fill (orange line) in the ESTX50, and then the half gap fill (orange line) in the DAX (half gap = (todays open - yesterdays close)/2 + yesterdays close) I was trading with a bullish bias. There were shorts available - I just didn't take them :-) Remember that we really have a SHORT bias for today, that is where I expected the major moves to be.

 

Image 3 - Afternoon-a

 

You can see I almost missed the opportunity to get long. In hindsight I would have got a better price taking the first test, however volume was too low for me to be convinced.

 

The more obvious test came here - you can see that the morning volume is now immaterial in comparison. We are seeing strong protection from Yesterdays Low up to today's Half gap fill.

 

Image 3 - Afternoon-b

 

Drift down to test for demand / squeezing weak longs. Opportunity to buy more here, a gift in fact.

 

Image 3 - Afternoon-c

 

Finally a push up, and we see major selling as we take out today's high in the DAX and find some stops. Notice how much further down (bearish) the ESTX50 is - we didn't even make it to today's high.

 

This is where I find having a view before hand helps - it would be easy to get out here. Longs were caught from prices above - a good 10+ points in the ESTX50. Unlikely someone would take that kind of hit. We should try to move higher.

 

Personally, I chose to reduce risk and cut half my position (the portion I bought in at on the second test down in Image 2).

 

Image 4 - Afternoon-d

 

We went higher than I thought - what likely happened was that those who were caught long finally got their positions back to break-even, and were able to push the market higher (with the new-found margin) to liquidate at a profit.

 

Our opportunity to sell came at a similar situation SoulTrader has mentioned -the standard test of yesterdays HVA worked very well. We had strong evidence of selling all the way up, and we had determined our major bearish bias before the day opened.

 

I mentioned at the start I was looking for the move down today - we never really got there. I was wrong, but trading isn't about being right or wrong, it's about making money.

 

Image 5 - Today (Friday) open

 

Finally, we get to today, the important part - WHAT HAS CHANGED? Nothing. The market opened basically where it closed. We have stepped through the last 2 days, and seen the pullback to the upside, and seen where the longs have had a chance to get out. Everyone is already short. This is one of those rare chances to just sell the open, and wait for some evidence of something to change.

 

Image 6 - End of Day

 

Nothing changed the whole day - there were minimal pullbacks, because no one 'big' was caught long. Anyone who missed their chance to get out yesterday was going to get killed today.

 

On these days, I find it best to spilt my position up between: 50% short in ESTX50, 30% short in DAX, 20% scalping the squeeze longs. This isn't a magic formula, it's just mine.

 

For hours we just went sideways - the action is basically: locals getting quick longs squeezing weak shorts all day, arb/spreaders/position traders selling it back down all day.

 

We saw strong volume as shorts took profit, likely to get out before the US holiday on Monday.

 

In one sentence we saw: reversal up EOD Wednesday, swing up Thursday, reversal down EOD Thursday, swing down Friday.

 

SMW

[firewalker 10]

On some occasions, a 'reversal' takes place very quickly. If you don't zoom in to a lower timeframe, you are left behind after the train has departed.

 

Here's one of two weeks ago. You can only see the first two hours of the day, but price closed around 12875 that day, making higher highs and higher longs all the way up to there.

 

[DbPhoenix 42]

  firewalker said:

On some occasions, a 'reversal' takes place very quickly. If you don't zoom in to a lower timeframe, you are left behind after the train has departed.

 

Here's one of two weeks ago. You can only see the first two hours of the day, but price closed around 12875 that day, making higher highs and higher longs all the way up to there.

 

 

But the reversal took place the previous afternoon. There's no reason to expect a test and retest every time price reaches a demand line, or supply line.

 

(It would help if you were to provide dates and times on your charts.)

[smwinc 20]

  DbPhoenix said:

But the reversal took place the previous afternoon. There's no reason to expect a test and retest every time price reaches a demand line, or supply line.

 

(It would help if you were to provide dates and times on your charts.)

 

exactly - that's the very reason I analyse the previous days. Often the reversal has already taken place before everyone arrives. For example, it is common for a reversal to occur in the European session (US-premarket), and have a false break on the US open.