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Trading 101

Trading 101: Trading Forex Swing Reversals

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Trading 101: Trading Forex Swing Reversals

Introduction

This article was posted on Saturday, 15:11, UTC.

It’s easy to get distracted by the plethora of trading strategies recommended online, where each new strategy you read about appear to promise more than the previous one. This is indeed a dangerous path to go down, and it will lead you nowhere in trading.

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Stop Looking For New Strategies

Most traders who are struggling with being consistent should stop looking for new strategies right away. If you find yourself constantly blaming your strategy for your losses and hunting for new strategies online, it’s time to simply pick one and stick with it for some time.

More likely than not, it is your implementation and execution of the strategy that is causing your problems, not the strategy itself. This is especially true for strategies that involve some degree of discretion, and are not purely mechanical.

Execution is Key

Instead of switching strategy, I recommend taking a closer look at how you are executing your trades. Check your trading journal and go back and take a look at the charts. Did you really follow your trading plan, or was there some part of the trade you should have executed differently that would have improved your result?

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Remember, reviewing your trades and your own performance is just as important as making new trades if you want to last as a consistently profitable trader.

Reversal Trading Strategy

In this article I will share one strategy that you can choose to stick with, optimize, and refine to fit your own style. It is not a 100% mechanical strategy, and thus involves some degree of discretion from the trader, including an understanding of how to use supply and demand zones.

Once you understand the concept of supply and demand zones, you will know that these are areas on the chart where price tends to consolidate before it “decides” on the next move. It may happen as a reversal in the opposite direction of the previous trend, a continued consolidation, or a spike through the supply/demand zone in the direction of the trend.

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For this trading strategy we are looking for potential reversals into the opposite direction of the previous trend. In the chart below, I have indicated the cluster zones that we call supply/demand zones.

To me, this is a chart that now looks “top heavy” and ripe for a sell-off at least down to the support zone in the 0.90 area and perhaps all the way down to the previous swing low at 0.60.

Wait For Confirmation

However, unless the market gives us any sort of confirmation about our short bias, we are not going to do anything except observing the price action. What we are looking for specifically would be a strong breakdown below the current resistance zone before we enter our short order.

Personally, I never enter before I see a red candle that breaks and closes below the 20 period simple moving average (SMA) line in a strong way. The 20 SMA in particular often works as a dynamic support line for the price, and a break through this line often gives trend followers an indication that the trend is broken, and that it’s time for them to get out of their trade.

By waiting for the strong break below the 20 SMA, the market has confirmed for us that the dynamic between buyers and sellers is changing. The bears are in control, and we can expect lots of stop-loss orders that are placed just below the resistance zone to be triggered, and thus reinforcing the sell-off.

Let’s take a look to see what actually happened in this case:

Indeed, we did see a strong break below the 20 SMA with several consecutive red candles. In this case, the market continued to fall for the next few months.

Reversal Trading Strategy Rules

Although this is a fairly discretionary strategy that requires you to make a judgment call on the overall market conditions, there are a few general guidelines that can help you spot the right setups:

  • Look for a strong previous trend in the chart, either up or down.
  • Highlight consolidation areas where the price is hovering around the 20 SMA, including all support/resistance zones above/below the current price.
  • Wait for price to break away from the support/resistance zone in a strong way and the candle to close on the other side of the 20 SMA.
  • Finally, enter your order if risk:reward is satisfactory and there are no obvious support/resistance zones nearby.

The first point is a very important condition for this strategy, as it is what makes it possible to get a strong reversal in the price. Without a strong previous trend, the reversal may be weak and not worth our effort as traders.

If you have previously been a trend trader, the concept of reversal trading may be a bit more difficult to get used to. However, as trend traders, we know how sharp the reversal often is when our dear trend ends. It can be violent and explosive to watch, and it hurts trend followers’ returns badly. As such, why not give the other side of the trade a chance and see if you can be more successful this way?

Featured image from Flickr.

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Fredrik Vold

Fredrik Vold

Fredrik Vold is an entrepreneur, financial writer, and technical analysis enthusiast. He has been working and traveling in Asia for several years, and is currently based out of Beijing, China. He mainly follows the stock and forex markets, and is always looking for the next great alternative investment opportunity.

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