The question is often asked as to how to best identify a pullback and avoid getting caught in a trend reversal. There are a few different factors to consider, but it boils down to two key components – context and price action.
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In terms of context, where in the trend is price most likely at? Beginning, middle, or closer to the end? One way to understand this better is to dial out to a higher time-frame to see where the market may be coming from or headed and if any major longer-term obstacles could stand in the way which might cause the trend to change. Always keep in mind the hierarchy of longer-term time-frames taking precedence over shorter ones – i.e. Weekly > Daily > 4-hr and so on…
Long-term level warns of trend reversal (weekly > daily)
Price action matters a lot in gauging whether it is a pullback or a reversal. Let’s say for example a market is trending higher and you think it could continue on but want to wait for a correction before entering. If a downturn in momentum is strong and continuous then it is likely signalling a larger reversal rather than a healthy, tradeable pullback.
Downward momentum strong and persistent
To help reduce the risk of getting caught buying or shorting a trend reversal, it is a good idea to wait for momentum to turn back in your favor. And even better yet at support for a long and resistance for a short. This gives you a better shot at timing it right and also a reference point from where to set your stop. Candlestick analysis can be a highly effective method for identifying turns in momentum by using some of the basic candlestick reversal patterns.
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Pullback to trend-line, candlestick reversal
For the full conversation and set of examples, please check out the video above…
—Written by Paul Robinson, Market Analyst
You can follow Paul on Twitter at @PaulRobinsonFX