Advanced Training: Reversal Trading

What is a Reversal?

A Reversal is pretty much what it sounds like; price turning and going in the opposite direction. Some reversals are merely retracements – the market taking a breath from a long run. Others are actual longer-term market direction changes. The actual definitions separating the two terms depend upon your point of view and actual don’t mean anything to our strategy. “Price turning and going in the opposite direction” covers it for our purposes.

How Do I Trade a Reversal?

Trading reversals is sort of like catching a falling knife. If you enter at the right time, you’ll catch the knife safely. Enter too late and you’ll miss it completely. Enter too early, you’ll get stabbed. Timing is everything in a reversal trade. We look for extreme price movements that are unreal and unsustainable. That’s when we look for our reversal entry.

Our reversal strategy uses the Bullet Money Management strategy to assist in timing your entries for more profit. Bullet Money Management involves adding to your position as the price continues in its prior direction until the reversal (retracement) actually occurs. It will ensure that you get in early enough to catch the reversal, but if you’re a bit too early, it will ensure that price doesn’t have to retrace very much for you to make profit on the trade series.

Strike 3.0 Reversal Strategy

The Strike 3.0 Reversal Strategy uses the Strike 3.0 Scanner, Strike 3.0 Exhaustion and Strike 3.0 MultiTrend indicators in addition to price action to find trade entries. Most importantly, we will check the longer time frames to be sure there is extreme,extended, unsustainable price movement showing before we enter the trade.

 

  1. Finding a trade entry begins with the Strike 3.0 Scanner. The scanner will provide an alert to a currency pair that is showing an extreme overbought/oversold condition on the 15 and 30 minute time frames (default.) If the scanner alert is set on, the scanner will sound and the pair name will change from black to red to indicate a signal on that particular pair. The arrow itself may disappear, but the pair name will remain red for 30 seconds (by default.)
    Strike 3.0 ScannerThe Reversal alert signal will only sound when there is a sufficient number of H4 candles in the opposite direction of our proposed reversal (6 by default.)
    The Overbought/Oversold condition on the Strike 3.0 Scanner is simply a reading of the RSI for the time frames mentioned. An RSI less than 30 or greater than 70 is required for a reversal condition on a specific time frame on the Scanner.
    In the image, you can see several reversal conditions on the scanner. In this case, all of the reversal conditions are showing buy signals, but the associated 4 hour bar counts (all are at 3 bars down) are not sufficient to trigger an alert.
  2. Check the 1 Hour, 4 Hour and Daily for extreme, unsustainable movement with very little retracement. This is the most important part of identifying a reversal trade. The more extreme the price movement, the more unsustainable the movement, the more likely a serious retracement becomes. If price has moved several hundred pips straight up (or down), the more pressure will be on the price movement to reverse. Here are examples of extreme price movements on the longer time frames:

EUR/AUD H4

AUD/CHF H4

GBP/CAD H4

GBP/USD H4

These moves require retracement. The market must breathe.

 

  1. Check for Reversal Signals on multiple time frames on the MultiTrend tool. There should be at least three. The more extreme the lower time-frame signals, the more imminent the move. The more extreme the high time-frame signals, the more movement can be expected.
    Strike 3.0 MultiTrend tool
    In this image, there are long reversal states on all the time frames from 1 minute to 4 hours. This represents an oversold condition of < 30 on the RSI on each of these time frames. The number represents the count of bearish candles currently in place. The count skips inside bullish bars.
  2. Look for a nearby Support/Resistance level to take a stand. If the price action is already showing reversal signs (pin bar, buy/sell signal, etc.), you may not want to wait for a “line in the sand”. But to get the best entry I recommend using a buy/sell limit order ahead of a support/resistance level to enter the trade.
    GBP/AUD M15
    This image shows a reversal entry I made last week. Since all the other indications were very extreme and price had just pushed through the 50 psychological level, I used a market order for the trade. Typically I try to use a pending order about 5 pips ahead of a psychological level.
  3. Enter the trade at or near support/resistance that you previously identified. Use ¼ – ½ of your normal trade size. That will allow you to add positions without exceeding your risk parameters if the market doesn’t immediately reverse (the Bullet strategy.)
  4. Target 30 – 50 pips on this trade, depending on the pair. GBP pairs will move more – especially GBP/JPY & GBP/NZD. As in all my strategies, I’m not married to the target. If price is floundering or going sideways, it could continue instead of reversing, so get some profit. You can always reload again if continues and you get another reversal signal. If you’ve chosen well, you should easily get 30 pips when the actual reversal occurs.
  5. If price continues to move without reversing (against your position), place a pending order ahead of the next psych level with increased trade size. Target your prior entry level. This is the Bullet Strategy.
    GBP/AUD M15 Pending
    In this image you can see where the pending order (buy limit) has been placed ahead of the 00 psychological level. If you’ve used sufficiently small size on your initial order, you can size this order up a bit (25% – 50%) so a retracement to the original order level allows you to shut down the original order at break even for a nice overall profit..
  6. Repeat until the reversal occurs, close all the positions when overall profit is achieved.
    GBP/AUD Reversal Exit
    This image is the result of the GBP/AUD trade above. You can see that the second pending position was never hit and I got a 28 pip profit on the first position. If you missed the initial exit and held, price action hit the pending second position and then hit the target for the second position, allowing you to exit both positions with overall profit.

    Strike 3.0 Money Management Tool
    You can use the Strike3-Money tool (lower left of your chart) to determine the overall profitability of all of your positions. Closed PL shows positions in this series already closed. Open PL shows total of open positions. Series PL shows profit of all open and closed positions.

  7. Be sure to close all pending orders when the trade is complete – you could have nasty consequences if you don’t.

The Strike 3.0 Reversal Strategy has been very profitable, but you have to give the trade time to work. If you time it properly, you should see a reversal in due time. Just be sure you do not exceed your risk parameters. Draw your line in the sand (in my case, the SD Amount in the Strike 3.0 Money Management above – if this reaches -$30, all positions are automatically shut down) and DO NOT EXCEED it. The line in the sand is to protect your trading account. That is your FIRST duty as a professional trader. If you blow out your account, you’re done trading forever (or until you can re-fund your account.) So, draw your line in the sand BEFORE you enter the initial position and NEVER exceed that line.

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