4 key points about Reversal you should know

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Types of Price Pattern

Stock Market trading is all about price. The concept is simple. You have to buy low and sell high. To execute this simple plan you need to predict price movement in future. The prediction is basically if the price will continue to rise or fall or will it change direction.

The first is known as Price Continuation in technical terms and second is known as Price Reversal. Lets assume that price rose today. Then traders will think will be continue to rise tomorrow or not. If it continues to rise tomorrow and day after it is price continuation. If it changes direction then it is price reversal.

The whole branch of Technical Analysis is study of this price behavior and prediction of it. Remember same thing we mentioned in Dow Theory chapter.

Key points about Price Reversal

In this chapter I will discuss important points about Price reversal. You may ask why not price continuation. Answer is if Price reversal does not happen then Price will continue it’s path. So you should look for price reversal points while analyzing Stock or Index.

1. Trend is required for Reversal

As mentioned in previous article there are three types of trends. Reversal happens only if prices are trending upwards or downwards. They will not occur in Sideways movement. Sideways movement create platform for uptrend and downtrend.

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If prices are trending then only trend reversal will occur. So first you need to make sure prices are in a trend. If there is no trend then you should not look for reversal patterns.

2. Trend Lines are important

The first signal of trend reversal is breaking of important trend lines. I have written series of articles on trend lines. In case you have not read those chapters then below are the links. You should read below chapters for understanding of Trend Lines and How to identify if trend line is broken.

The first two points tell you the basics of trend reversal. Price should be trending and it is possible to draw trend line. If you are unable to draw trend line then it becomes difficult to identify if trend line is broken. So drawing trend line correctly is utmost important.

Above 3 chapters provide details on trend line drawing and addresses common problem in drawing trend line.

3. Trend reversal strength

Note in support and resistance chapter and founding principle of technical analysis chapter I mentioned that usually prices retrace 33% or 50% or 66% (at max) of original price movement in reversal.

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Note all of the reversal price movements are in percentage. What does it signify? It tells you that if price during uptrend moved 100 points then chances are that during retrace prices can easily move 33 points or 50 points or at max 66 points below.

So the larger the original trend is the larger the reversal will be. So above point about trend reversal strength justifies the basic principle of technical analysis. The strength of trend determines the strength of reversal.

4. Volume is important

Price and volume are backbone of technical analysis. So far we have discussed about price. Price is more reflected and visible on charts and everywhere. Volume takes a back seat. But it is as important as price.

If the volume is more means more number of people are trading the stock that day. If prices move upward with great volume means more people thing prices will increase in near future. The same is true for downtrend as well.

For price reversal in case of uptrend (that is uptrend reversal) volume is not that important. People tend to book profit at higher levels and due to lack of buyers volume may be less but prices will fall.

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But in case of downtrend reversal volume is very important. At lower levels people sell due to panic and buyer should be more convinced for prices to move upwards. So volume is important.

Conclusion

In next chapter we will see important Trend reversal patterns. Before diving into trend reversal patterns I wanted to discuss these important points. Without understanding these basics concepts it was meaningless to discuss Reversal patterns.


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