Stock Market Reversal - How To Trade A Reversal


by Dave Wooding - Date: 2006-12-04 - Word Count: 368 Share This!

Do you know how to spot a stock market reversal? And just as important, do you know how to position yourself for profits from a reversal?

The most straightforward way to identify a reversal is to check the closing price relative to the opening price and the previous bar's closing price. If you are a trader using the daily time frame looking for a reversal to the upside, then a reversal would include a closing price on the daily chart greater than the present day's open and greater than the previous day's close.

What this tells you is that buyers are in control relative to the traders from the beginning of the trading day and the end of yesterday.

This definition of a reversal is just the start. Even better is if a reversal occurs at previous support or resistance levels. By definition, support and resistance levels are were reversals have already occurred. It makes senses that previous support and resistance levels would repeat.

Going further, if a stock breaks out of a well defined trading range and does so convincingly, then comes back to the break out point, you have the opportunity for a low risk trade. What you want to look for is a pullback in price to the break out level with a price bar that forms a reversal. Savvy traders will look to positions themselves after a stock forms a reversal and then trades above (for a long position) or below (for a sell short position) the reversal bar.

Once a position is taken, a stop order on the other side of the reversal bar's range is placed for catastrophic loss protection. All traders, or should I say, all old traders, use stop orders for protection.

Assuming the stock moves favorably, following the price with a trailing stop that stays above or below the previous day's range - depending if you are long or short - keeps you in a trade for an extended period without giving back up profit.

Reversal bars provide the opportunity to enter a stock at a price that provides the most upside potential with out giving back significant profits. Additionally, these type of trades typically lose the least amount of money when you use practical stop loss orders.


Related Tags: trading, support, stock market, resistance, reversal

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