What is a Forex Reversal Strategy?
Forex reversal strategies are when a forex trader will look to buy or sell currency pairs when price is about to change direction. Those who trade with a reversal strategy will often look to enter a position after a price pullback into a trend followed by a correction. They may also look to enter reversals from highs and lows within a range bound market, buying at the bottom of a range and selling at the top of the range. One the riskier methods of trading reversals is to try and pick the top and bottoms of an established trend.
Some forex traders would exclusively trade reversal opportunities whereas other would combine multiple forex reversal strategies along with a forex trend trading strategy and forex breakout strategy, depending on the current market conditions.
Reversal strategies can be very flexible, thus making them suitable for forex scalping, day trading and swing trading. Reversal trades can occur over the short, mid or long-term. I tend to find that the higher chart time frames give more reliable signals primary due to the fact they contain more data and more traders are following them. I believe that they can help to filter out some of the noise that often occurs in the lower chart time frames. This also means less time spent watching charts with ample opportunities to find potential reversal trade setups.
Forex currency pairs can be analyzed for reversal signals by using technical indicators to spot overbought/oversold areas such as the CCI and Stochastics. Drawing support and resistance levels on your charts can also help to identify areas for potential reversals whilst it would always be beneficial to be aware of economic news releases as these can cause volatile market conditions.
What are the Advantages of a Forex Reversal Strategy?
With so many currency pairs to choose from and multiple chart time frames, there is always the possibility to look for reversal trading opportunities. This is great for those who do not have much time to dedicate to trading. Not only do reversal occur frequently on currency pairs, but they can be found on any other trading instrument including stocks, commodities and cryptocurrencies.
You can even set alerts via email or SMS to send you notifications when a reversal trading signal has appeared according to your reversal strategy. Alerts will save you from having to constantly stare at the charts all day waiting for reversal to happen. This could for example be when price reaches a support/resistance level or there is an overbought/sold signal within an established trend
Reversal trading strategies can be very easy to implement once you know how to identify a ranging or trending market. There are plenty of technical indicators built into online trading platforms that can help you to easily identify market conditions. Indicators such as the ADX and MACD can help identify the current market situation. The important part will be timing your trade entry, which can depend on if you are looking to trade a reversal during a trend or within a range.
Of course, as with any trading strategy, there will need to be sensible money management in place. Reversal strategies can be very flexible which makes them suitable for a variety of different trading preferences. You can scalp just a few pips from within a range or look to enter a long-term trend on a reversal. Reversal trading strategies can be used for short and long-term trading and in unison with different trading strategies. You do not need to trade reversal exclusively but they can form an integral part of an overall trading strategy.
Fundamental factors can work in favor of reversal trading strategies. If there is a major news release that occurs during a reversal in favor of its direction, this can increase momentum and give traders the opportunity to catch some big moves. On the other hand, if there is no news due to be released and the markets are generally very quiet, it can be a good hunting ground for reversal trades.
I find trading towards the NY close and Asian open can give some good conditions for reversal trades although spreads can be higher during these market hours. I would personally prefer to use an ECN forex broker in order to get trades executed at the best possible prices with tight spreads and reliable execution speeds.
What are the Disadvantages of a Forex Reversal Strategy?
Forex reversal strategies can perform poorly if traders are not identifying significant enough market ranges and trends. I have often seen beginner traders using lower chart time frames and trying to spot ranges or trends that do not have enough importance in the overall bigger picture. This can lead to lots of false signals and poor money management as a futile attempt to compensate for poor analysis.
You may often find that a reversal trade on one-time frame be a completely different signal on another time frame. I often sport a potential reversal on one-time frame only to see that it is contradicting a strong trend against the reversal on another. Therefore, I would always verify a reversal trade is relevant by confirming it across as many time frames as possible, especially the higher chart time frames which I find can have more significance over the mid-long term. Long term chart time frames are often watched by more market participants including big players such as banks and funds. This can give them a greater emphasis.
A forex reversal strategy is unlikely to perform well without additional analysis on other factors such as fundamentals and price action. For that reason, the success rate can depend on much more than simply spotting a reversal trend. I would combine all types of market analysis with a forex reversal trading strategy to filter signals.
If the trader is not using sensible money management and does not plan stop losses effectively, a reversal trading strategy can cause them to be whipsawed in and out of the market. It is important to realize that not every single trend trade will come to fruition and there will be losses which is a completely normal part of trading any forex strategy. Furthermore, I would only take reversal trades that give a favorable risk to reward ratio of at least 1:3 so that one losing trade does not wipe out consecutive winners.
Forex Reversal Strategies
There are thousands of forex reversal strategies that you can find online. You can also use the technical indicators built into trading platforms to create your own bespoke reversal strategy template that suits your individual trading style. One of the main ways of trading reversals is to spot if there is a market range and then look to either trade a reversal at either side of the range. The other popular wat of trading reversals is to spot a trend and wait for a reversal to get you in the trend at a favorable price.
Range Reversal Strategy
The forex range reversal strategy is when you wait for price to reach the top of a range for a sell trade or the bottom of a range for a buy trade. It anticipates that price will bounce back off (reverse) from either side of the range. Often, a trend trader will mark a range using support and resistance levels and use an overbought/oversold oscillator to identify a reversal.
- Mark support and resistance on the chart to identify a ranging market
- Wait for price to reach either side of the range or place a limit order
- Use an oscillator to find overbought/sold market conditions
- Confirm range trading signal with price action analysis
- Enter trade as price reverses
- Place stop on other side of range or recent high/low. Take profit once the opposite side of the range has been reached. Some traders may also lock the trade in at break even and stay in the trade longer to try and gain additional pips. You should of course adapt money management according to your own trading style as everyone is different.
Trend Reversal Strategy
This forex reversal strategy looks to enter a trend when price makes a pull back against the trend direction before continuing in the original direction. Often, a trend trader will use an overbought/oversold oscillator to identify a pullback into a trend. An oversold market during a pullback in an uptrend could suggest soon price will soon continue to increase.
- Use multiple moving averages to identify market trend
- Use an oscillator to spot a pullback into the trend and conduct price action analysis to show market is turning
- Enter on continuation of trend
- Place stop on opposite side of trend or recent high/low. Take profit once the trend has come to an end. Some traders may also lock the trade in at break even and stay in the trend longer to try and gain additional pips. You should of course adapt money management according to your own trading style as everyone is different.
Forex Reversal Strategy Conclusion
Forex reversal strategies are very popular and flexible to suit all different trading styles. Finding reversals on your charts is the easy part. The key to success with a reversal trading strategy will most likely be down to your money management, having a good trading plan and trading discipline along with controlled trading emotions.
Furthermore, I would combine multiple technical analysis, fundamental analysis, price action analysis and sentiment analysis to filter all forex reversal strategy signals. You should trade forex in a way that suits your own individual style, needs and goals.
If you would like to practice forex reversal strategies, you can open an account with a forex broker and download a trading platform completely free of charge. If you are looking for a forex broker, you may wish to view my best forex brokers for some inspiration.