What is a reversal?
A reversal is a change in the direction of an asset's price. It can be positive or negative, e.g. when an upward trend loses momentum and the price of an asset starts to move downwards. It is the opposite of a continuation, when an asset's price carries on moving in a certain trajectory.
Where have you heard about reversals?
You'll often see references to specific types of reversal in the financial press. For example, when an asset starts to climb in value following a downward trend, this is called a “rally”. When an upward trend ends and a downward one begins, this is described as a “correction”.
What you need to know about reversals
When it comes to the stock market, reversals can occur on a number of occasions during the same day.
Time frames of reversals are very important. They may occur in intraday trading and proceed over days, weeks and months. An intraday 5-minute reversal doesn’t matter to a long-term investor, who is watching weekly or daily charts. However, it can make a difference for a day trader.
There are different ways to identify trends and their reversals. Many trading platforms, including Capital.com, offer an extensive range of technical indicators, which help to spot emerging trends and upcoming reversals. These include: Moving Averages (MA), Trendlines, Relative Strength Index (RSI) and On-Balance Volume (OBV).
Good analysts always keep a close eye on closely related stocks, in order to gain an understanding of the wider market and better predict price reversals.
Reversal vs. pullback: what is the difference?
Reversals are sometimes hard to predict and to differentiate from short-term pullbacks, or so-called “noise”. While a reversal denotes a change in an asset’s price trend, a pullback is a shorter-term counter-movement within an existing trend.
Reversals always start as potential pullbacks. The challenge is to spot whether it is only a pullback or the real thing, a full-on price reversal.
Those traders who misidentify reversals for pullbacks and vice-versa can therefore incur significant losses and miss out on potential profits, either by not sticking with a good thing or by not pulling out at the right time.