Forex is the short form for Foreign Exchange and it is a market where currencies from different countries get traded. In this market, traders buy or sell currencies at current rates to make a profit.
What is a reversal strategy?
A reversal strategy in Forex trading means that a trader takes advantage of price movements going against their ‘trend’, i.e. when a currency stops going up or starts going down instead of continuing its previous trend. This strategy works well if the ‘trend’ has been strong enough to have lasted for some time and it’s possible to determine the very moment when the trend might be reversed.
In Forex trading, several factors affect prices through what is known as technical analysis. These include the foreign and domestic money supply and inflation rates, interest rates, and more. While some of these factors can be controlled, others cannot.
How to use a reversal strategy
To trade using a reversal strategy in forex trading, traders should learn how to identify the trend in prices at any given time. This makes it possible to determine when the trend might reverse. In this context, the most popular ways of identifying trends involve looking at charts with different types of price activity over a certain period of time. These trends give clear indications if a currency is going up or down after a specific time interval.
Every type of charting used for comparison involves plotting two sets of data against each other by using lines within the chart area itself. One set of data is known as ‘trend lines’ and the other one is called resistance and support levels. Trend lines are usually straight or wavy lines that connect at least three or more low points (or high points) in the chart area. Resistance levels are shown by horizontal lines around prices where many traders will attempt to sell at these price points. As for support, this is defined by a series of ascending prices, meaning it’s the level where buyers congregate to buy what they can afford before it goes up even more.
When these patterns become visible on charts, it shows that there might be a reversal coming soon, i.e., when the trend line changes direction and starts going down instead of continuing its previous direction upwards. This strategy works well if the trend has been strong enough to have lasted for some time and it is possible to determine when exactly it might be reversed
The two types of reversal trading
There are also two types of reversal patterns in Forex trading: reversal candlestick patterns and reversal bar patterns. Candlestick patterns are graphical formations that are made up of one or more candlesticks. These formations give clear indications as to whether a trend might reverse or not. Bar patterns, on the other hand, refer to the different types of bars that can form on charts and these also give indications to reversal moves.
Reversal strategy in Forex trading is based on the assumption that when a currency has been going up for some time and it reaches a resistance level, it is likely to start going down instead. This happens because, at this point, many traders who have bought the currency at lower prices will attempt to sell it at higher prices, thereby reversing the trend. The opposite is also true; when a currency has been going down for some time and it reaches a support level, this is likely to start going up again. This happens because, at this point, many traders who have sold the currency at lower prices will attempt to sell it at higher prices to take advantage of an increasing trend
Another example where the reversal strategy works well is when you see that there are no more buyers or sellers in the marketplace. As soon as this happens, most individuals with prior knowledge regarding the situation would go against the flow and try to sell their currencies in case they want to get out of trading them altogether. This can be seen in what is known by traders in Forex trading as; ‘no-trade zone’.
When one applies this strategy cautiously and doesn’t rely on it too much, it can be a very effective means of profiting in Forex trading. It is important to remember that not every trade will result in a reversal and sometimes the market will just move sideways. So, as always, traders should use stops to help protect their positions and minimize potential losses.