Price Action Reversal Strategy Warnings

Many traders like to find ways to short the tops and buy the bottoms so they seek out price action reversal strategies so they catch the turns. There is a time and place to use a reversal strategy and the key is to know when the move is failing.

More often than not, the stronger trend will assert itself and if you are not using appropriate risk measures, you could be looking at a loss much greater than anticipated if the move fails with strength.

It is vital to understand when a move is not playing out as expected and to take appropriate action to avoid an unplanned loss.

Bullish Bar Reversal in USDCAD

This Forex pair has been in a steady downtrend for a year (time frame dependent) and after a strong push downwards of 14%, price began to consolidate. After swings were registered, we were able to start a trend line (demand line) on the bottom of price.

I’ve left out the top trend line that would form a trend channel to keep this example focused. I’ve also left out many fanned trend lines except for the small red initial line.

1. Price puts in a clean double bottom pattern that starts the drive to take out the swing high on the left. After the high is registered, price begins its decent.
2. The decent halts in the area of the previous double bottom and that is a fairly clean, albeit low volatility move away from the level. We are also able to connect two swing point for our demand line.
3. After another clean rejection just to the right of the #2 label, price rallies and after putting in a higher high (uptrend pattern), price drops to reject off the previous low giving us a double bottom and an obvious bullish reversal candle.
4. Price makes a tentative approach to the demand line (price action would point to low interest at this point and a probably hold of support) and 5 days of CAD gains are cleanly wiped out.

In all of these cases, there was never a warning shot given as price approached support that we’d lose the level. If there was a trend channel drawn, you can see that trading this range would not have been too difficult (although real time may have caused you some issues).

Range Break and Price Action Signs Of Danger

A great way to read price is to ask yourself what should happen if “A” happens. An example of that is #3. Price found support and rejected with a pin bar and then two bull candles right after which broke highs.

That’s a true sign of strength and something you’d expect to see given the context of the play.

What if the pin formed and price didn’t move?

As price once again approached the demand line and previous low rejection with strength zone, price began to consolidate. It’s a hard fought battle and the last highlighted candle breaks support.

Not shown but on the one hour chart, you can see how that candle formed. It had bearish implications as price broke to the upside of the consolidation first then broke support.

Important information? There are a few ways that candle could have formed and would it change your opinion of the support break if price broke lower first and then took the high of the consolidation? Food for thought.

We get the obvious pin bar and what would you expect to happen?

1. Would you expect consolidation or would you expect clean rejections like the previous ones?
2. Would you expect to see the large bear candle if it was a strong arrow of support?

These are the types of questions you need to ask yourself in real time. Forget that Canada was set to release interest rate news the next day (they held on rates) but just looking at price would not point to strength. Reading the price action would alert you that the bulls are in jeopardy and a long play could get painful.

To be fair, the pin bar reversal strategy would have had you playing long at the break of the pin (fakey – never liked that name. Price is seeking volume.) and clearly there was buying interest prior to the break.

Was that momentum red candle brought to life by those hitting the exits when price didn’t soundly reject the low and trade back inside the range?

You Trade What You See On The Chart

I’m sure there are quite a few people boasting that they took part in this quick upside move because they read the pin bar play. However, price action was not pointing towards upside at the point before the news release. In fact, the day before closed on its lows eating up the pin buyers and those that came before it.

I will be transparent….I was set to play the upside move and cancelled my order when there was no follow through and we had momentum to the downside. There was no trade for me and the trade was not simply because there was a pin bar. It was context and I read it as a failure test of lows.

So where are we now?

Who knows. I don’t forecast and just trade what I see. Will this upwards move continue on this massive volume relative to recent history (CAD futures) or, since the market likes to hurt the most people, will it turn and take out the long heavy candles we just formed?

Let the price action tell you the story and you just read along.

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