18 YOURTRADINGEDGE MAR/APR 2010

CURREnCY CORnER

ll trends come to an end. Bulls take the market too high or bears take the market too low. Eventually, price returns to the fair market value. What are the keys to spotting a reversal?

You must understand what a trend is.• You must know where the bulls and bears are •waiting.

A bullish trend is defined as a series of higher highs and higher lows. A bearish trend (see figure 1) is defined as a series of lower highs and lower lows. When either of these is happening, you should expect them to continue. As Newton observed: “An object in motion stays in motion.”

As great as trends are, they don’t last forever. They eventually get rejected by support or resistance. Change is due at first to profit-taking by trend traders. If too many traders exit their positions, countertrend traders see this as weakness and attack. Thus a reversal is born.

Traders should always identify where support and resistance is (see figure 2). It could take the form of visual tops and bottoms. It could be daily or weekly pivot points. It could be primary and secondary channel lines. It could be a psychological number, such as X.X00 or X.X50. Often it is a combination of two or more of these. It is your job to identify support and resistance in advance. If you can do this successfully, you can anticipate the trend’s ambush and have a contingency plan in place.Now let’s put the trend rejection to work.

The first thing you will see is a clear rejection at your support and resistance line. Very often it’s an engulfing candle. That’s good. You may also see an overbought/oversold oscillator. But price action is the best indicator. A clear rejection, which everyone can see, is best. It will cause the slow trend traders to take profit a bit late and open the window for scalpers to jump into the counter trend (see figure 3).

The next thing to look for is a break in the trend (see figure 4), such as a higher high in a downtrend or a lower high in an uptrend; neither belongs in these patterns. If you spot this after a support and resistance rejection, you should spring to action – but don’t trade yet! You have simply made an observation. At this point you have only gathered intelligence. Now you must formulate a strategy.

The entry strategy is to anticipate the new trend. If the old

a

CurrenCy CornerWayne McDonell provides analysis of the currency market: the beginning of the end.

FiGURE 1 : BEARiSH TREnD

FiGURE 2 : SUPPORT AnD RESiSTAnCE

FiGURE 3 : SUPPORT AnD RESiSTAnCE LinE REJECTiOn

Traders should always identify where support and resistance is (see figure 2). It could take the form of visual tops and bottoms. It could be daily or weekly pivot points...

www.yTemagazine.com

MAR/APR 2010 YOURTRADINGEDGE 19

CURREnCY CORnER

trend was bearish and you have just identified a higher high, then a new upward trend should produce a lower high at some point – and that is your entry. You want to ‘buy low’: as long as the low is higher than the support line.

In such a situation, I like to use a Fibonacci study and look for a pullback of 38.2%–6.8%. That is my entry zone. If price temporarily pulls back into the new trend, I’m expecting a green candle somewhere in that zone. If I see it, I have permission to take action.

As always, there are no sure things in forex. This pattern does not have a 100 per cent success rate. However, it is an easy one to spot if you are looking for it in advance; aka ‘having a trade plan’. Practice on a demo account until you have a track record of success.

To watch the 22-minute companion video to this article, please visit: http://www.fxbootcamp.com/yte/123-forex-reversal-patterns

May the pips be with you.

Wayne McDonell is the Chief Currency Coach of FxBootcamp.com, a live forex training organisation. He is a member of the US National Futures Association and registered as a Commodities Trading Advisor. His book ‘Strategic and Tactical Forex Trading’ (Wiley Publishing) is a bestseller in the Foreign Exchange category of Amazon.com.

FiGURE 4 : BREAK

FiGURE 5 : EnTRY

yTemagazine.com

www.yTemagazine.com