Bullish trend reversals explained by FXTM expert

Traders spend many hours and days exploring ways to enter the market the fastest way possible.

In a quest of discovering the “holy grail” of the best market entry, they study Japanese candlestick reversals, contrarian theory, oscillator divergence, wave theory, and many other theories just to mention a few. Novice traders tend to rely mostly on indicators and oscillators alike to place their orders. The more indicators and oscillators they study, the more they incorporate them in their strategy.

One of the most neglected indicators and oscillators is price. Yes, price! Price is the best indicator, anything else is secondary. Price discounts everything, that is, economic, political and geographical information. Beginners find it difficult to rely on price, mostly due to lack of knowledge, and most of the time they ignore it or assign lower weight to it.

The best market entry is of course the trend reversal. After a prolonged trend in one direction, the market will signal the end of the prevailing trend and the beginning of a new one in the opposite direction. There are many reversal patterns but in the scope of this article, inverse head & shoulders, double bottom and triple bottom will be the main focus.

Inverse head & shoulders

Inverse head & shoulders appear at the end of a downtrend. After a series of successively lower tops and lower bottoms there comes a point where that last bottom fails to break lower than the previous one. It is the point where demand overcomes supply and buyers enter the market aggressively pushing prices higher.

Inverse head & shoulders description

1. Existence of an established downtrend.
2. Downtrend is defined by successively lower tops and lower bottoms.
3. Volume (where available) signals alerts.
4. The downward move to the head is associated with decreased volume (where available) signalling a warning.
5. Right shoulder is higher than the previous bottom (head), warning for an impending reversal.
6. A decisive close above the neckline with increased volume (where available) signals the end of the downtrend and the beginning of a new trend, uptrend.
7. Minimum price target may be calculated by projecting the height of the pattern to the breakout point on the neckline.

Triple bottoms

Just like inverse head & shoulders, triple bottoms signal the end of a downtrend and the beginning of an uptrend. This price pattern consists of three equal bottoms (or almost equal) and then a decisive close above the top (resistance) of the formation. It is very important that prices manage to break above the top of this formation in order to have a triple bottom reversal in place.

Triple bottoms description

1. Existence of an established downtrend.
2. Downtrend is defined by successively lower tops and lower bottoms.
3. Volume (where available) signals alerts.
4. The downward move to the support is associated with decreased volume (where available) signaling a warning.
5. The bottoms are equal or almost equal forming the support area of the pattern.
6. A decisive close above the resistance with increased volume (where available) signals the end of the downtrend and the beginning of a new trend, uptrend.
7. Minimum price target may be calculated by projecting the height of the pattern to the breakout point.

Double bottom

As long as the price action forms successively lower tops and lower bottoms the downtrend will be in force. Supply is greater than demand and sentiment is negative pushing prices to lower levels. First signal of weakness will appear when volume (where available) decreases on the way down. Another warning is the failure of the last bottom to move lower than the previous one. Double bottom trend reversal will be complete when prices break above the resistance with increased volume (where available).

Double bottom description

1. Existence of a prior trend (downtrend).
2. Downtrend is defined by successively lower tops and lower bottoms.
3. Volume (where available) signals alerts.
4. The downward move to the bottom is associated with decreased volume (where available) alerting for an impending reversal.
5. The two bottoms are equal or almost equal forming the support area of the pattern.
6. A decisive close above the resistance with increased volume (where available) signals the end of the downtrend and the beginning of a new trend, uptrend.
7. Minimum price target may be calculated by projecting the height of the pattern to the breakout point.

Conclusion

Bullish trend reversals come in many flavours. Even though traders and especially beginners like to experiment with candlestick reversals and oscillator signals at extreme levels, they rarely explore price reversal patterns. The truth of the matter is that price is the boss and as such everything else is secondary. Price charts reflect all economic, political and environmental information. Price reveals the crowd’s, that is the market participants’ psychology. High probability reversals are based on price patterns that are easily recognisable on the chart. Volume where available as well as oscillator analysis may confirm reversal patterns for higher accuracy.

-- Written by Andreas Thalassinos, head of education at FXTM.