Successful trading is 90% waiting and 10% execution – which is the exact reason why trading is so challenging and typically leads to account blow ups. I call myself a reversal trader but what this really means is that I catch trends very early on when they are just forming and then ride those trends with the momentum well before the regular trend following trader comes in.

Most traders who claim to be reversal traders are just trying to call tops and bottoms and predict market turns well in advance. Successful reversal traders enter WAY after the top or bottom has formed. To trade reversals profitably, you have to be ok with watching your setup unfold while you are standing on the sidelines and waiting for the perfect moment to jump on it.

Step 1: Find a higher time frame level

This is the basis for all reversal trades. Zoom out to your higher time frames – usually the 4H or Daily time frame. Now draw lines at those level that really stand out and that have been the origin of previous price movements.

Both, support/resistance and supply/demand level concepts can be used to identify high impact price levels. The most important thing to keep in mind that trading those levels blindly – just with pending orders waiting at the level – has nothing to do with reversal trading and is purely predicting market moves and standing in front of an approaching train.

Often, reversals will happen in mid-air and not at your chosen levels – those are low probability trades and you shouldn’t start trying to get into such reversals.

Step 2: Higher time frame reversal signal

Once price comes to your level, being patient is of great importance. Often, you won’t get a clear signal and price will just take off without you – learn to accept that. Your method won’t be able to catch all moves; that’s what trading rules are for: filtering out the majority of price movements and only exposing yourself to high probability setups.

Typical higher time frame reversal signals are momentum divergences on your RSI or MACD and a spike through the outer Bollinger Bands® . Completed Fibonacci sequences also add confluence to your trade.

Still, this is not a signal and you still have to wait a bit more. Those higher time frames reversal signals typically occur at market tops and bottoms where many amateur traders enter trades way too early without an edge. We wait until the reversal has already moved in our favor.

Step 3: Lower time frame entry timing – find the broken market structure

Not entering prematurely after you have identified the higher time frame signal and before the lower time frame entry trigger is given is the hardest part of successful reversal trading. You could probably enter earlier on some trades, but you’d significantly reduce your winrate and then run into emotional problems with your trading.

On the lower time frame, you have to wait for the confirmed reversal entry based on market micro structures. Typically, we look for a reversal pattern based on the analysis on highs and lows. If you are waiting for a short trade after a market top, you wait to see lower highs and confirmed lower lows. Trendline breaks and support/resistance breaks are the typical entry triggers here.

Step 4: Staying in the trade and exiting the trade

When it comes to staying in the trade we rely on the Bollinger Bands®s exclusively. As long as price stays between the middle and the outer Bands, the reversal is still valid. Even a spike through the middle Bollinger Bands® is not an exit signal – only a closethat violates the middle Bollinger Bands® is a trade exits.

To get consistent results, it’s important to make consistent trade decisions. If you use the 1H time frame to time your trade entry, you should stay on the 1H time frame to make trade exit decisions.

Challenges of reversal trading

Emotionally, reversal trading is among the hardest trading methods. So why do I still prefer this trading method? The reason is that, although it is difficult, not every trader is born to be a trend-following trader and some traders are naturally drawn to reversal trading. At the same time, every new trend starts out as a reversal and understanding reversals helps you understand the markets in very deep way.

Here are the 4 top reasons why reversal trading is so difficult for most people:

1 – Don’t use pending orders when price is approaching your level. Don’t stand in front of an approaching train

2 – Accept to miss the first part of the reversal. No calling tops and bottoms for you anymore.

3 – Even when you see signals on the higher time frame, you have to wait for a confirmed structure break on the lower time frame – waiting is a big part of reversal trading

4 – Not all reversals lead to entries. Don’t chase a move that did not give an entry

There are different types of reversals and in our Pro Area, you will learn all of my 3 setups and a variety of re-entry signals and setups. And you will also get my best setups every Sunday:

Bollinger Bands ® are among the most reliable and potent trading indicators traders can choose from. Bollinger Bands ® can be used to read market and trend strength, to time entries during range markets and to find potential market tops. Bollinger Bands ® are a dynamic indicator which means that they adapt to changing market conditions and, thus, have benefits over other standard indicators which are often perceived as ‘lagging’. In this article, we show you how to use BBollinger Bands ® to improve your chart reading skills and to identify high probability trade entries.

In our pro Forex trading course, you will learn how to use the Bollinger Bands ® to find and time entries step by step.

Bollinger Bands ® explained 101

As the name implies, Bollinger Bands ® are price channels (bands) that are plotted above and below price. The outer Bollinger Bands ® are based on price volatility, which means that they expand when price fluctuates and trends strongly, and the Bands contract during sideways consolidations and low momentum trends.

By default, the Bollinger Bands ® are set to 2.0 Standard deviations. However, we suggest setting the Bollinger Bands ® to 2.5 Standard Deviations to make them wider and capture more price action. With the 2.5 standard deviations, 99% of all price action falls between the two bands, which means that a violation of the outer bands becomes a much more meaningful signal as we will see (watch the video at the end for more info about that).

The center of the Bollinger Bands ® is the 20-period moving average and the perfect addition to the volatility based outer bands.

Trend-trading with the Bollinger Bands ®

In contrast to most other indicators, the Bollinger Bands ® are non-static indicators and they change their shape based on recent price action and accurately measure momentum and volatility. Thus, we can use the Bollinger Bands ® to analyze the strength of trends and get a lot of important information this way. There are just a few things you need to pay attention to when it comes to using Bollinger Bands ® to analyze trend strength:

• During strong trends, price stays close to the outer band
• If price pulls away from the outer band as the trend continues, it shows fading momentum
• Repeated pushes into the outer bands that don’t actually reach the band show a lack of power
• A break of the moving average is often the signal that a trend is ending

The screenshot below shows how much information a trader can pull from using Bollinger Bands ® alone. Let me walk you through the points 1 to 5:

1) Price is in a strong downtrend and price stays close to the outer bands all the time – very bearish signal.

2) Price fails to reach the outer band and then shots up very strongly, even showing an engulfing pattern. This is a classic reversal pattern where the bearish trend strength faded.

3) 3 swing highs with lower highs. The first swing high reached the outer band whereas the following two failed – fading strength.

4) A strong downtrend where price stayed close to the outer band. It tried to pull away, but bears were always in control.

5) Price consolidates sideways, not reaching the outer band anymore and the rejection-pinbar ended the downtrend.

As you can see, the Bollinger Bands ® alone can provide a lot of information about trend strength and the balance between bulls and bears.

Finding tops and bottoms with Bollinger Bands ®

After setting your Bollinger Bands ® to 2.5 standard deviations, you will see that price reaches the outer bands less often. At the same time, the meaning of such signals becomes much more important because it shows significant price extremes.

We highly recommend combining the Bollinger Bands ® with the RSI indicator – it’s the perfect match. There are two types of tops that you need to know about:

1) After a trend move, price fails to reach the outer Band as the uptrend becomes weaker. This signal is usually accompanied by an RSI divergence >> Continuation signal

2) During a consolidation, price spikes into the outer Bollinger Bands ® which get rejected immediately >> Reversal signal into the short direction

The screenshot below shows both scenarios: the first is the market top after a divergence – see how the trend became weaker and lost momentum and then eventually failed to reach the outer Band before reversing. I marked the second spike with an arrow – this was a trend continuation signal as price failed to break higher during the downtrend. The strong spike that was followed by a fast rejection showed that bulls lacked power.

The role of the moving average

During trends, the moving average holds very accurately and a break of that moving average is usually a meaningful signal that the sentiment has shifted. The screenshot below shows nicely how price trended between the outer bands and the moving average both on the way up and down. During the trend, the moving average could have been used as a re-entry signal to add to existing positions during pullbacks.

Furthermore, the moving average can be used as a trade exit signal where a trader does not close his existing positions unless price has broken the moving average. By combining the Bollinger Bands ® with the moving average, a trader can already create a robust trading method.

You can see, the Bollinger Bands ® are a multi-faceted trading indicator that can provide you with lots information about trend, buy/seller balances and about potential trend shifts. Together with the moving average and the RSI, Bollinger Bands ® make for a great foundation for a trading strategy.

See the Bollinger Bands ® in action

I am a big believer in chart patterns and there are a few that can produce very reliable signals. However, it’s never about the patterns themselves, but what those chart patterns tell you about the market dynamics and how traders move price.

In this article I want to explain how to “decode” any chart pattern so that you will be able to understand price movements in a much better way. In the second part we will take a look at the 4 best chart patterns and how you can use them to make better trading decisions.

The 3 components of chart patterns

All chart patterns, whether it’s the Head and Shoulders, triangles, wedges, pennants or the Cup and Handle, are made up of the 3 same components. If you understand how to read those 3 components, you can make much better trading decisions and understand price in a new way.

#1 The foundation: highs and lows

Although it sounds very basic, the analysis of how highs and lows shape on your charts builds the foundation of any chart pattern analysis. We will get into the nitty gritty soon, but all future chart analysis is based on understanding highs and lows.

Higher highs and lower lows

The first premise is that higher highs signal a healthy uptrend, while lower lows signal a downtrend. We will soon learn about the nuances of highs and lows and get into the advanced concept, but this is the starting point.

Lower highs and higher lows

When you see that price fails to make a new high or low, it can serve as an early warning signal that a change in direction is imminent.

The screenshot below shows that price first stopped making lower lows during the downtrend and then even started making higher highs and higher lows. This is a classic trend change pattern and patterns such as the Head and Shoulders or the Cup and Handle are built upon this principle as we will see later.

#2 Strength of a trend: length and steepness of trend-waves

The strength of a trend  is defined by the individual trend waves that exist between the highs and lows. Here, you should specifically look at the length/size and thesteepness of those individual trend waves to get a feeling for trend strength.

In the screenshot below you can see that the first trend-wave (first black arrow) was very steep and long. The second wave was less steep and shorter in duration. The final third trend wave was much shorter and also just barely broke the previous high – we also saw more price wicks which are another rejection and exhaustion signal. Putting all the clues together, the reversal could have been anticipated by understanding the concepts of trend-wave length and steepness.

#3 Strength of trends II: depth of pullbacks

Once you have identified that price is in a trend, the pullbacks within that trend can provide valuable information of what might happen next.

The screenshot below shows an uptrend with many consolidations and retracements in between. However, just before price reversed into a downtrend, the final retracement was much larger in size and duration, showing that something had changed in buyer-seller sentiment and balance.

Whereas a short and shallow retracement means that the ongoing trend is still intact, when retracements become more frequent and larger in size, it can foreshadow a potential trend shift as buyer and seller balance is slowly shifting.

Part 2 – Understanding the 4 best chart patterns

Usually, chart patterns are not that clear cut and far from the textbook examples that you’ll usually find in trading literature or on other trading websites. Thus, it is even more important to understand how to decode chart patterns to make the right trading decisions.

We will now take a look at the 4 most commonly traded and discussed chart patterns and see how our previous 3 principles apply to each one.

Triangles

A triangle shows a temporary period of consolidation within a trend or at the beginning of a new trend. During an uptrend, a triangle is formed when the retracements and pullbacks become smaller and smaller; buyers step in earlier each time to push price back up. Triangles are much more reliable during established trends as they signal accumulation of positions before the next trend continuation.

Head and Shoulders

A Head and Shoulders pattern signals a potential reversal and by decoding the individual parts of this chart pattern you’ll quickly see how this pattern describes sentiment shifts nicely:

From the left shoulder to the head, price makes a higher high. Often, the left shoulder forms after an ongoing trend and the head is then usually just the last push. Then, the right shoulder fails to make a new high which is the first indication that the trend might be over. The break of the neckline then signals that price is going to make a lower low, confirming the trend reversal.

Being able to interpret highs and lows is all you need when it comes to reading the Head and Shoulders pattern.

Double Top / Double Bottom

Double tops and double bottoms are reversal patterns as well and, similar to the Head and Shoulders pattern, the reasons and underlying dynamics are the same:

The second top, which fails to break the first high, signals that there are not enough buyers to push price higher anymore. Therefore, when you see a double top or double bottom it often signals a shift in price dynamics. If the double top is then followed by a break lower and new lows, the trend shift is confirmed.

Cup and Handle

The Cup and Handle pattern is also just a series of highs and lows; the Cup and Handle formation below shows a slow transition from a downtrend into a new uptrend. First, you see a series of lower lows, followed by a consolidation at the bottom of the Cup and, finally, price starts making higher highs. When then price breaks the top of the Cup, the uptrend is confirmed. A potential Cup and Handle that does not break the previous highs becomes a double top pattern.

Conclusion: Try to understand what price tells you

As you can see, you can understand and decode all major chart patterns by looking at how highs and lows form, how steep and long trend waves are and how deep retracements are. This knowledge also enables you to estimate the quality of chart patterns and it will help improve your chart reading abilities as well.

Let’s recap what we have learned about the building blocks of chart pattern analysis:

(1) Highs and lows build the foundation of all chart analysis

(2) A first shift in sentiment occurs once price stops making higher highs or lower lows

(3) The length and the steepness of trend-waves define the overall trend strength

(4) The depth of retracement in between trend waves tells you a lot about the balance between buyers and sellers

Trading is all about being able to read market structure, sentiment and the balance between bulls and bears.Understanding if a trend is gaining or losing momentum is important if you are trying to make decisions about whether support and resistance levels are likely to hold or break, if a trend will continue, or if a reversal can be expected any time soon.

In a different article, we talked about how to understand the direction of a trend; this article explains how to read the trend strength from your charts. The following 6 concepts, tools and indicators can help you make sense of price action and provide insights about market structure.

1) Price action analysis

Trend waves – length, steepness and smoothness

The first point lays the groundwork for all that follows and it describes the basics of price movement. The way price moves during trending waves and pullbacks can tell you a lot. The chart below shows a downtrend with a series of lower lows. At the same time, you can see that the bearish price waves are much smoother and the bullish pullbacks are less smooth.

Secondly, the steepness of the bearish price waves decreases and they becomeshallower as the trend continues. Steep price waves indicate trend strength whereasshallow price waves signal a lack of strength. Also, the size of the trend-waves is important to understand. The chart below shows that the bearish trend-waves become smaller.

The blue circled area highlights the first period bears faced strong opposition and price wasn’t able to move further down as smooth. This price behavior is in sharp contrast to previous price action. In a strong and healthy downtrend, the bearish trend-waves do occur mainly uninterrupted.

Pullbacks during a trend

The next screenshot highlights the importance of putting the size of pullbacks into context:

• The first green shaded area shows the first larger pullback during the ongoing downtrend.
• Before that, the pullbacks were relatively small which signaled strong momentum to the downside. Often, strong trends only show sideways ranges instead of real pullbacks.
• A large pullback can foreshadow a broken market structure and it provides first indications about losing trend strength.
• Finally, price failed to make lower lows altogether which had been foreshadowed by the increasing size of pullbacks against the downtrend.

2) The slope of trendlines

Trendlines are a great trading tool because they provide instant information about the strength of a trend. First, you have to pay attention to the angle of a trendlinebecause the angle shows you exactly how strong the trend is. In an uptrend, a small angle means that the new lows are not moving up as fast. However, once the angle becomes too large, it often signals a trend (Boom) which is not sustainable.

An increase in the angle of trendlines means that price is gaining momentum and price is making higher highs faster.  Finally, a break of a trendline signals a broken market structure. A break can either mean a decrease in the momentum of a trend or a complete trend reversal.

• The slope of trendlines describe trend strength
• An increasing slope in an uptrend shows a trend with rising momentum
• A decreasing slope shows fading momentum
• The break of a trendline is the final signal of a trend reversal

3) Bulls vs. Bear and micro-structures

We already touched on this topic when we talked about pullbacks earlier but there are a few more things that we can use to our advantage when it comes to analyzing the dynamics between bulls and bears during trending phases. There are a few things a trader needs to be aware of when analyzing a trend and tries to estimate the strength:

• A trend where candle bodies do not overlap signals strong strength because price keeps going into one direction without pulling back significantly
• When candlesticks show no or only small wicks, it also signals a strong and healthy trend
• Candlesticks are roughly the same size and are not too large. If you see that suddenly candlesticks are becoming very large, it means that volatility is increasing. This often happens when markets approach a top or a bottom
• If you see gaps, especially on the daily timeframe, those gaps don’t close and price keeps trending\

4) Rejected reversals

The way failed breakouts and rejected reversals occur on your charts is a big tell as well. Here are the most important patterns and characteristics when it comes to analyzing failed reversals during trends:

• Price does not overshot trendlines or when it does, it never closes beyond a trendline
• When a trendline breaks, there is only a sideways move and no immediate reversal
• Reversal spikes get immediately rejected and covered
• Pullbacks into moving averages are very quick and price does not stay long at a moving average

5) ADX

The ADX measures trend strength and it is non-directional which means that it cannot tell you which direction price is going – it only tells you if the trend is gaining or losing momentum.

The chart below shows a downtrend and the first down-movement shows a lot of strength in the ADX by making a new high and absolute on the ADX. The next two bearish moves were much smaller and not as strong and the ADX confirmed it by showing lower highs. The last move on the far right showed a very choppy and narrow movement and the ADX went dipped at that point, price had entered a range.

• A rising ADX shows gaining trend strength
• New highs on the ADX signal a healthy trend
• Lower highs on the ADX signal losing strength
• A “hook” on the ADX shows a sudden shift in trend strength
• A flat or an ADX heading down signals a range

6) Moving averages (MA)

The relation of price to the MA and the slope

Moving averages are a great trading tool because they provide a variety of different information at once. First, the slope of a moving average is important. When price is above the MA and the MA is moving up it signals a strong trend with prices rising faster than the historical averages. The further price can pull away from a moving average, the stronger the current trend is. The longer price can stay on one side of the moving average whithout touching the moving average, the stronger the trend.

The MA crossover – sentiment shifts

The combination of a smaller and a larger moving average measures sentiment shifts in price. The screenshot below shows a chart with a 50 and a 100 MA. When the small MA crossed above the larger MA it signaled a shift in sentiment to the upside because recent prices were moving above the average of the longer term price structure. Conversely, when the shorter MA crossed below the larger MA it signaled a sentiment change to the downside because recent price started trading below the longer-term average.

The space between MAs – momentum information

Finally, the bigger the space between the two MAs, the stronger the trend is becoming because recent price is pulling away from the long-term average faster. The size of space between the two MAs provides information about momentum. The MACD or the Ichimoku indicators are both based on the differences between short term and long term average price structure.

• Generally, price above a moving average signals an uptrend [read about Marty Schwartz’s trading tips]
• When the short-term MA crosses above the long-term MA, it signals a bullish trend shift
• When the space between the two MA increases, momentum increases as short-term prices pull away fast from the longer-term average price

7) RSI

The RSI is another indicator that measures strength. It is similar to the ADX but the RSI is directional. In a healthy uptrend, the RSI makes new highs and higher lows. In a downtrend, the RSI makes new lows and lower highs. In a range environment, the RSI moves sideways between 30 and 70.

The screenshot below shows that the first uptrend was initiated by a RSI divergence (higher lows on the RSI and lower lows on price – a momentum divergence). During the following uptrend, the RSI made higher highs and higher lows. After the uptrend, price moved down for a while but not with a lot of strength and the RSI stayed mostly between 30 and 70 (dotted arrow). The next uptrend-phase also started after a RSI divergence and the RSI started making higher lows again until, just recently, another divergence signaled the end of the uptrend.

• During an uptrend, the RSI makes higher highs and higher lows
• A flat RSI ranging between 30 and 70 indicates a lack of momentum
• An RSI divergence shows a momentum divergence and it is often a reversal sign

8) Bollinger Bands ®

Bollinger Bands® can be combined with other momentum indicators but they are also a great tool by themselves. The screenshot below shows a healthy uptrend and the Bollinger Bands® showed that as price stayed above the middle Band; price “grinding” higher between the middle and the outer Band is a typical trend signal.

A trend is usually broken once price crosses the middle Band. A price spike outside the outer Band which immediately reverses back into the Bollinger Bands® can often signal a change in trend direction.

• In an uptrend, price moves higher between the middle and the outer band
• A break of the middle band often signals a trend reversal or the lack of momentum
• A price spike through the outer bands and an immediate reversal indicates a sentiment shift

Knowing the strength of a trend is the backbone of any trading method

Understanding trend strength and being able to read the balance between bulls and bears is a very important skill every trader has to develop. And although each of the 6 described tools and concepts can be very helpful, you should pick 1 (maximum 2) of to avoid confusion and indicator redundancy.

The trading tools and concepts described are not a standalone system by themselves, but they should build the backbone of any trading methodology.