When trading, it’s extremely important to predict how the current trend is going to behave. After all, it’s how you understand when to close your position and take profits. However, even when a trend seems to end, there may be two options: either it’s really over and you should act, or it’s just a small pause in the trend, and it’s going to continue going in the same direction, so you should wait. In this article, we are going to tell you how to see the difference between these two options using technical analysis.
Pullbacks and reversals
Let’s say, you’re following a trend in hopes it will continue in the same direction and bring you notable profits. However, the trend suddenly changes its direction. When it’s just a small pause, and the trend continues in the same direction after a few candles, that’s called a pullback. You can try and wait it out to save your position, so there’s no need for immediate action. But if the trend really changes and will probably go in the opposite direction for a long time, that’s called a reversal, and you should act.
It doesn’t matter where your trend is going: pullbacks and reversals may occur on both downward and upward trends. You should pay attention to all sudden changes and check them with various technical analysis tools to understand whether the trend has really changed for good. Sometimes reversals are caused by fundamental changes, but we won’t discuss that. Instead, we’ll try to answer this question: how do you identify pullbacks and reverses?
One of the easiest ways to spot a trend reversal is to look at trend lines. For example, if your trend is going up, draw a trend line by joining two or more lowest price points. When the price breaks the line, it means that trend is probably going to reverse. Moving averages (MA) are also great for identifying these things: for example, a 200-day moving average crossing a trend often means it’s a reversal.
Pullbacks are pretty similar to reverses, and that’s the main difficulty here. Moving averages are also used here very often: even when a trend seems to go down, faster-moving averages above the slow ones can tell you the price is still going up. Bollinger bands is another useful tool for identifying trend changes, and it’s pretty user-friendly. However, you should remember to learn how to use an indicator before you actually start trading with it.