If you are trading Forex, you need to know about Forex trend reversal because of course, if you are trend following, you need to know when to take profits. If you are a contrary trader looking to get into a new trend, you need to know how to time your move into the new potential trend with the best risk to reward.
What is the best Forex trend reversal indicator?
There actually is no best trend reversal indicator but there are many which if used in the right way will help you gain better market timing and greater accuracy with your trading signals. Lets look at a few.
You can see many chart formations which can warn of market tops and bottoms and double tops and triple tops are ones which are commonly used by traders. Ones we also like are – head and shoulders tops and bottoms and rounding ( or saucer) tops and bottoms.
There are many candlestick formations which can indicate a chart reversal and one of the most popular is “the hanging man” “ dark cloud cover” “Harami” and “Harami Cross” to name just a few. The reason why candlestick chart formations are so good in terms of spotting a reversal is the relationship between the open, high, low and close and the way the candle is drawn to reflect this which reveals the psychology of the traders. There are certain candlestick formations which warn that an existing trend is reversing.
The stochastic has been around since the late fifties and was devised by George Lane and remains one of the best indicators of all for spotting a trend reversal. The stochastic measures the velocity and speed of price of any currency pair. The way to use the stochastic is to watch for divergence of the stochastic indicator from the price trend which can warn of reversals in price. The stochastic is basically very simple to use:
When the stochastic is above 80 or below 20, a reversal is normally imminent. You then need to watch for bullish or bearish divergence against the prevailing trend and look to take a position on the crossover. Of all the trend reversal indicators you can use, we like the stochastic the best.
Relative Strength Index
The RSI or Relative Strength Index shows how strong a price is by comparing downward and upward close-to-close movements. The indicator comes from J.W. Wilder and was first featured in his classic book “New Concepts in Technical Trading” which was first published way back in 1978 but it still remains one of the most popular indicators today with FX traders. The way to use the indicator is simple:
The RSI can be used to identify an overbought level when it moves up above 70, and an oversold level when it moves below below 30 and this warns a counter trend move could be coming. We like to use more extreme levels and tend to look for, set ups which are above 80 and below 20.
Bollinger Bands give you a measure of Standard deviation which gives an indication of the volatility of any currency pair, by measuring how widely the current price is dispersed from the average price or mean price.
The bigger the difference between the real time price and the longer term average price, the higher the standard deviation or volatility of the currency pair will be. So why is this so important?
In any currency pair, the value of the market tends to rise slowly over the longer term. Prices may become volatile in the short term, but these short term price spikes which move away from the average, tend to be short lived and are a reflection of greed and fear. All price spikes tend to fade and prices will normally come back to longer term moving average. When prices spike violently to the outer bands or exceed them, you can start looking for, a trend reversal back to the average or mean price.
Using Reversal Indicators in Your Trading Strategy
The trend reversal indicators outlined above, can all be effective at spotting market tops or bottoms but as with all indicators, you need to work them into an overall strategy, with rules and which you have confidence in. Also keep in mind, any indicator you use will not be reliable all the time and there is no one best Forex reversal indicator.
If you use the above reversal indicators in the right way, you will soon find yourself trading with better odds of success with your trading signals. This will help you to lock in profits before a trend ends or spot a new trend developing and trade it with better risk to reward.