A reversal is a change in the price direction of an asset. A reversal can occur to the upside or downside. Following an uptrend, a reversal would be to the downside. Following a downtrend, a reversal would be to the upside. Reversals are based on overall price direction and are not typically based on one or two periods/bars on a chart.
Conversely, in a bearish market, a reversal consists of rising price action from an absolute low made during a preceding downtrend.
The opposite of a reversal is a continuation, or when an asset’s price trend holds.
A reversal shows that the price direction of an asset has changed, from going up to going down, or from going down to going up.
They can also often be referred to as trend reversals.
When it starts to occur, a reversal isn’t distinguishable from a pullback.
A reversal keeps going and forms a new trend, while a pullback ends and then the price starts moving back and continues in the trending direction.
A reversal may occur suddenly within seconds, or it may gradually take days or weeks to develop.
No matter the duration involved, all that is needed for any market to undergo reversal is increased participation and an imbalance of supply and demand.
As an abundance of buy orders hits the market, price rises; as order flow becomes dominated by sellers, price falls.
Technical traders use a variety of chart patterns and price action techniques in order to identify when a reversal may occur.
These include watching for completed chart patterns such as double tops and bottoms, triple tops and bottoms, and a head and shoulders.
Reversals can be challenging to identify during formation, but they are easily recognizable after they develop.
Listed below are the types of reversals in relation to rising and falling price action:
- Uptrend: The uptrend is defined as a series of periodic higher highs and higher lows, with its eventual end marked by absolute high price value. Reversal begins at the absolute high and consists of price action trending downward, establishing a series of periodic lower highs and lower lows.
- Downtrend: The downtrend is defined by a series of periodic lower highs and lower lows, with its eventual end marked by an absolute low price value. Reversal commences from the absolute low and is marked by upward trending price action, establishing a series of periodic higher highs and higher lows.