Definition, Illustration, and Trading Approaches for Reversals

Definition, Illustration, and Trading Approaches for Reversals

What Is a Reversal?

A turnaround is a modification in the price trend of an asset. A turnaround can take place in either direction, upward or downward. A reversal to the downside would take place following an uptrend, whereas a reversal to the upside would take place following a downtrend. Reversals are determined by the overall price trend and are not typically determined by one or two periods/bars on a chart.

Specific signals, such as moving averages, oscillators, or channels, can aid in identifying trends and detecting reversals. Reversals can be distinguished from breakouts.

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Key TakeAway
  • A market reversal occurs when the price movement of an asset changes direction, either shifting from an upward trend to a downward trend or from a downward trend to an upward trend.
  • Traders aim to exit positions that follow the trend before a reversal occurs, or they will exit once they notice the reversal starting.
  • Reversals are generally associated with significant changes in the price movement that signal a shift in the overall trend direction. On the other hand, minor fluctuations in price against the trend are often referred to as retracements or periods of consolidation.
  • As it begins to happen, it can be difficult to differentiate between a reversal and a pullback. A reversal is a lasting change in trend direction, whereas a pullback is a temporary correction in price that is followed by a resumption of the trend.

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What Does a Reversal Tell You?

Reversals convey a change in the direction of the price trend of an asset, and they can happen swiftly in intraday trading or over longer periods of days, weeks, or even years. The relevance of a reversal depends on the time frame of the trader: a five-minute reversal on an intraday chart may not be relevant for a long-term investor monitoring daily or weekly charts, but it is crucial for a day trader.

A bullish trend, characterized by a sequence of higher swing highs and higher lows, turns into a bearish trend by transitioning to a sequence of lower highs and lower lows. Conversely, a bearish trend, marked by a series of lower highs and lower lows, transforms into a bullish trend by transitioning to a series of higher highs and higher lows.

Trend identification and reversal spotting can be accomplished by examining price action alone as mentioned earlier, or traders may choose to employ indicators. Oscillators can aid in identifying both trends and reversals. An oscillator above a certain threshold indicates an uptrend, whereas an oscillator below a certain threshold suggests a downtrend. A drop below the threshold could indicate a potential reversal.

There are multiple techniques that traders use to spot trend reversals. While some rely on price action and indicators, others use trendlines to identify reversals. In an uptrend, traders may draw a trendline along the series of higher lows. If the price drops below the trendline, it could signal a potential reversal. However, it's important to note that trendlines are subjective and can vary depending on the trader's interpretation.


If spotting reversals and differentiating them from noise or brief pullbacks was easy, trading would be a cakewalk. Unfortunately, this is not the case. Even when using price action or indicators, many false signals occur. Additionally, reversals can happen so swiftly that traders are unable to react in time to avoid significant losses.

Example of How to Use a Reversal


The diagram illustrates an upward trend moving within a channel, creating higher highs and higher lows overall. The price initially breaks out of the channel and falls below the trendline, indicating a potential shift in the trend. Furthermore, the price creates a new low that is lower than the previous low within the channel, providing further evidence of a reversal to the downside.

The price then proceeds in a downward direction, forming a sequence of lower highs and lower lows. A reversal to the upside can only take place when the price establishes a new pattern of higher highs and higher lows. However, an early indication of a reversal could be a break above the downward trendline.


The example also emphasizes the subjective nature of trend analysis and reversals. Despite the price making lower lows in relation to a previous swing several times within the rising channel, the overall trend remained upward.

Difference Between a Reversal and a Pullback

A reversal in the price of an asset denotes a change in trend direction, whereas a pullback refers to a temporary counter-move against the trend, which does not reverse the trend. An uptrend consists of higher swing highs and higher swing lows, where pullbacks create the higher lows. Therefore, a reversal in the uptrend would only occur when the price drops below the previous swing low on the timeframe being observed. Reversals typically start as potential pullbacks, and it is uncertain whether they will eventually become pullbacks or actual reversals.

Limitations In Using Reversals

Neglecting to consider reversals can lead to taking more risk than intended in financial markets. Prices invariably reverse at some point and will experience numerous ups and downs over time. For instance, a trader may have believed that a stock moving from $4 to $5 would become much more valuable, and thus rode the trend higher. However, the stock eventually drops to $4, $3, and then $2. Signs of a reversal were probably noticeable well before the stock reached $2, possibly even before it hit $4. By paying attention to reversals, the trader could have secured profits or avoided a now losing position.


Once a price trend begins to reverse, it is often difficult to determine whether it is a pullback or a full reversal. By the time it is confirmed to be a reversal, the price may have already moved significantly, resulting in significant losses or erosion of profits for the trader. As a result, trend traders often opt to exit their trades while the price is still moving in their favor, avoiding the need to determine whether a counter-trend move is a pullback or a reversal.

Misleading indications are also an actuality. Even though an indicator or price action may indicate a reversal, the price can swiftly resume moving in the previous trend direction.

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