What Is a Reversal?
A reversal is a change in the direction of an ongoing trend. This could be a shift from an uptrend to a downtrend, or vice versa. They are a fundamental aspect of price action that are present in all markets, and therefore a crucial concept for traders to understand.
By definition, they occur at inflection points of movements in price. Therefore, they represent one of the best opportunities in trading. By the same token, they also represent one of the greatest dangers to your unrealized gains.
It all depends on which side of the trade you are on.
The key is learning how to make sure you’re on the right side more often than not.
How Reversals Work
The concept of a reversal is pretty simple.
When price rises for a period of time, we call it an uptrend. When price falls for a period of time we call it a downtrend. A reversal occurs when the current phase changes from one to the other.
From a fundamental perspective:
Buying pressure overtakes selling pressure or selling pressure overtakes buying pressure. As always, price is determined (mostly) by supply and demand. When more people are buying it goes up. When more people are selling it goes down.
This is what we call the battle between the bulls and the bears.
Sentiment can shift based on a number of factors. However, understanding those factors isn’t necessarily as important as the ability to recognize that a reversal is occurring.
That’s when you can begin to consider making trading decisions.