#203: How to Trade a Reversal and Retracement
In this video:
00:28 – How to tell if the market is trending, in a reversal or a retracement
00:48 – The result of the US Election
01:21 – Strength in the USD and GBP
01:50 – A reversal or a retracement?
02:35 – I use Bollinger bands to help identify where the market is trading
05:30 – Consider the Daily strength to assist your trading
08:01 – Trading from the right hand side of the chart is what makes a good trader
How can you tell if the Forex market is reversing or it's just in a pullback or a retracement? Let's talk about that and more right now.
Hi Forex Traders, Andrew Mitchem here from The Forex Trading Coach, this is video and podcast number 203.
How to tell if the market is trending, in a reversal or a retracement
I want to talk about a question that I've been emailed from Darren in the UK who said, “Hi Andrew, can you talk about whether, or how to tell whether a market is trending, it's pulling back or it's in a reversal or a retracement?” It's an issue that we all face as traders.
The result of the US Election
I'm going to talk about that really shortly, but first before we get into that, I‘ll need to just talk about the US election because on last week's video and podcast, I said, I wonder what's going to happen? I suppose in all honesty, against all odds, Donald Trump will be very shortly the next US president, number 45 I believe. It just goes to show out there that you just cannot tell what's going to happen because of course all the polls were suggesting Hillary Clinton was a clear winner, but reality said that it was not to be.
Strength in the USD and GBP
Right now, actually the US dollar, although it was pretty volatile when it came out, the US dollar is actually strengthening a lot and interestingly, also is the British pound. I suppose with the British and the Brexit issue. In someways there is some similarities between voting for Trump, and so it's actually given strength to the British pound which is quite interesting. Just keep an eye on your charts and your trading, and really trade what you see on the charts.
A reversal or a retracement?
Back to the topic of today's video and podcast, how do you tell if you're in a reversal part of the market, or how do you tell if that trend is going to continue? Let's say the market is moving up and you get a reversal signal, and how do you know that's going to reverse the wrong way, or how do you tell that's just going to pull back a little bit and then continue upwards again and of course the same for a sell trade but in reverse. Really, it's very difficult. Right at the time of the reversal signal, it's very difficult you don't really know whether that's going to be the start of a massive change in direction or that's just going to be a slight pullback and then it continues again.
I use Bollinger bands to help identify where the market is trading
There's a few things that I use that can help you with to find out more, and I use Bollinger bands. I love Bollinger bands, they give me a fairly good guide to what part of the chart that prices in right now. Because, if you just have price on your charts, it's really hard unless you're of course, you're using support and resistance lines, and round numbers, which I use as well. Without Bollinger bands, it's really hard to see if the market is sort of likely to reverse or likely to pullback. I'll give you some examples. I'd love to use reversal signals when the market is … When I see reversal signals and the market is nearly upper or lower Bollinger band.
If you've had a lovely trend upwards, and go and look at your charts, it doesn't matter what time frame chart. You've had a really good move upwards, a good strong move upwards, and you see a great reversal signal, or potentially even better. An indecision candle, and then a reversal signal all showing around the upper Bollinger band. The likelihood is that the market will then pullback. Same in reverse at the bottom Bollinger band, the price has been moving down, and down, and down. Then you get a bullish signal at the bottom Bollinger band.
Price for whatever reason, and it's quite uncanny how it happens, seems to like to go from upwards to lower, to upwards to lower Bollinger bands. In general, it doesn't happen all the time. When you see a reversal, let's say at the top of a Bollinger band, and it's a bearish sell set up. It's a great opportunity to look at selling, and riding the market back down. You need to be mindful of a few things. If you see that happening, in theory, a reversal signal has, I suppose a slightly higher risk because you are trading against let's say in this case, a big uptrend. You have to be mindful of a few things. This reversal signal might just be short lived, it may just be a small pullback.
If you see the pullback go to the middle Bollinger band, and then stall at that area, and then maybe you see a bullish signal, that to me is the great continuation pattern. We've seen the uptrend, we've had the pullback. Whether you've taken to or not, it's pulled back and it's now stalling and looking like it's going to be bullish again from the middle Bollinger band. That to me is a safer trade setup, that's what I call a continuation pattern, because you're now trading in the overall uptrend but after we've had the pullback. That to me is a really good strong lower risk setup.
To answer Darren's question, if the market, let's say burst through that middle Bollinger band, and keeps going. The likelihood is it can't, again, depending on previous highs and lows and round numbers et cetera, but the likelihood is, the price will then try to seek out the lower Bollinger band. That then could be … When it gets to that level, that's the opportunity to look for bullish signals again as a reversal after the down trend.
Consider the Daily strength to assist your trading
The other thing that I personally also consider is the daily strength, and if I see clear let's say on the British pound/US dollar, clearly is an example.
Let's say I'm seeing lots and lots of strength in the British pound against the US dollar and the price is already at the upper Bollinger band, and I see a reversal. I've got to think very carefully whether I want to take that trade or not because it's trading against my likely longer term direction. If I did take a sell trade there, and the setup was good, I'm mindful, and I'd be more inclined to monitor the trade, because it's trading against my daily direction, my longer term biased. I could either take the trade and think, well, I'm going to be watching this trade a little bit more carefully or I ignore the trade.
If the reversal happens, great, I'm not in the market, it doesn't matter. I'm there waiting for the market to pull, like to stop that reversal, to pullback, stall, ideally let's stay at the middle Bollinger band and then see the goodbye bullish setup to then look to ride the market back up again. Because, in that instance, I have my daily direction, let's say I even have my weekly direction all showing bi-trades for the British pound/US dollar. The market's moved up, it's become exhausted, it's pulled back. It's then stalled at that certain level, let's say I have a round number in there or a daily pivot point as well or previous high, it's balanced at that level.
Then, I then get the great opportunity to trade with my longer and my medium term direction, and right now on my shoulder time frame chart, whether it be a full out chart or one out chart, 15 whatever minute, whatever, it is you trade. You are then seeing that great opportunity to take the British pound/US dollar up again with all the safety of those longer time frame charts knowing fully well that you're in an uptrend right now but you've just had a small pullback. Now I'm looking to ride it up again. In most cases, you can have a very small stock loss on those trades, and the likelihood is, you're going to get a very high reward to risk out of that trade.
I hope that helps in terms of looking for reversals, pullbacks, et cetera over retracements. Go and have a look at your charts, look at any time frame chart, and put those Bollinger bands on. When you see those reversal signals or those stalling of a trend, and they happen around those upper or lower or middle Bollinger band, that gives you a great opportunity to know what part of the chart you're in right now.
Trading from the right hand side of the chart is what makes a good trader
When you're trading from the right hand side of the chart, the hardest part is knowing where you are right now. In hindsight, it's all very, very easy of course, but you need to be able to do this in real time. That makes a difference between an average Forex trader, or a losing Forex trader, and a very, very good Forex trader.
I hope that helps. This is Andrew Mitchem from The Forex Trading Coach. I'll look forward to bringing you more news, information, Forex trading tips this time next week.