Forex Reversals How To Identify and Trade

There are three types of forex reversals. In this lesson we will explain how to spot all three types of forex reversals, and how to trade them profitably. The methods we describe for locating and trading reversals is proven and accurate. Traders will increase their ability to trade reversals profitably. Trading reversals is important because a reversal is usually a fresh movement on an H4, H1 or larger time frame, by nature, which means you are trading at the beginning of a move.

What Is A Forex Reversal?

If a forex pair is in a downtrend on the larger time frames, a reversal would be a change in direction where it goes back up with a strong movement on the smaller time frames. It could be a sudden, short-term reversal against the major trend or a complete change of direction and trend. Same scenario for a pair in an established uptrend that reverses and goes down.

What Types of Reversals Will Forex Traders See?

There are three types of forex reversals that traders will see. The first type (Type 1) is when a currency pair moves in one direction for a long time, like 8-10 days or more, then stalls at support or resistance. The pair then forms a large cluster of support and resistance going sideways. More often than not these pairs break out of the cluster in the opposite direction of the previous movement cycle. Here are some sketches and examples of a Type 1 reversal:

Learn how to set up these trend indicators.

Look at the Type 1 reversal examples above, a pair drops for many days, then stalls into a support cluster and is "setting up" for a reversal back up, probably after a news driver. This can also happen with pairs that move up for a long time setting up for a reversal back down.

The second type of reversal (Type 2) is a pair that is ranging in a wide range between support and resistance. You can see these types of reversals developing on the smaller time frames and many times the larger time frames also. The reversals occur over a matter of days. This happens because either the base currency or cross currency is changing directions, examining both currencies with multiple time frame analysis in the pair will reveal the exact reason. Here are some examples:

The third type of reversal (Type 3) is a V-shaped reversal and is a somewhat sudden and unexpected movement against an established the trend. These reversals usually start with the lower time frames like the M30 or H1 time frames plus a strong signal from The Forex Heatmap ®. Most of the time these reversals are news driven. Look at some examples here:

In the above example the GBP pairs are dropping and trending down. Then the scheduled GBP news causes a reversal. But the forex news calendar can be checked daily and if you have significant profit in the GBP sell trade you can scale out lots or exit the trade as you see fit. Then after the GBP news you can catch a reversal and buy trade going back up.

A Type 3 reversal might also occur because overall market or one of the currencies in the pair is choppy and reverses every other day anyway.

Look at the image above, the EUR/USD is choppy on the D1 time frame. If you drill down the charts to the smaller time frames, you can see that the M30 or H1 time frame cycles up or down about every 2 or 3 days.

Can Trading Forex Reversals Be Profitable?

Yes, most definitely, Type 1 and 2 trend reversals are much easier to see, anticipate and trade profitably. These are normal and customary trade entries. Type 3 reversals might require some day trading skills or a little more experience, but the potential reward makes it worth it. You can always demo trade Type 3 reversals. On Type 3 reversals just make sure you follow our trade entry procedures and trade with a stop order. Manage the trade by moving the stop order to breakeven, plus scale out lots. When the pair stalls at support or resistance after the reversal movement, you can scale out lots or exit if the trade is against the major trends on the higher time frames. Thereby treating the reversal trade like a shorter-term trade.

If the USD/JPY is in a strong uptrend it could reverse back down after some USD or JPY news. If this happens, you enter the sell USD/JPY using the same procedures as any other trade. You use the The Forex Heatmap plus the smaller time frames for your trade entry. Except since the USD/JPY is in an overall uptrend the sell trade might be only for one day or possibly until it stalls and forms support. Then you could exit the trade, suspecting it could reverse back up into the longer term trend. The larger time frames always provide context for any reversal.

How Many Lots Should I Trade For Each Reversal Type?

Type 1 and 2 reversals are easy to see forming on the charts over several days and as the reversals develop. Type 3 reversals (V shaped reversals) are more sudden but mostly news driven so they can be somewhat more difficult to spot. But if the market is choppy and pairs are reversing every other day on time frames like the M30 or H1, then it can be more tricky or treacherous and you may want to trade fewer lots than normal or demo trade, and exit much sooner than a regular trend-based trade. Trading reversals in a choppy market can be profitable but the risk is still higher and the potential reward is lower than trend trading with stable charts. In choppy market, for the day-to-day reversals we would instruct traders to trade less lots or not trade at all.

How To Avoid Getting Caught In A Reversal

Example: if you sell the GBP/USD and it is trending down on the D1 time frame. You enter the sell trade and are up 40 pips. At this point move your stop to breakeven. If it continues lower you can exit the trade with more pips with zero reversal risk, assuming your broker has guaranteed stops. If you sell the GBP/USD and it is trending down, there is always a possibility that it could reverse back up, tomorrow or 5 days from now, so make sure your stop order is at breakeven for zero reversal risk. These are our standard money management procedures. If there is GBP or USD news the next day or even in a few days and your stop is at breakeven, you are in great shape because you will either make a lot more pips or take a breakeven stop. This is infinitely positive money management ratio.

This is true for GBP or USD news on the news calendar or unexpected news. If a reversal occurs on the GBP/USD and it goes back up, it becomes an opportunity to make pips on the buy side, even though you lost nothing on the original sell.

Conculsions About Forex Reversals - Reversals can and will occur at some point on the pair you are trading. This comprehensive guide will keep you on the right side of the trend and still allow you the freedom to trade reversals on the smaller time frames. Most reversals occur based on scheduled news drivers on the news calendar.