Trend reversal patterns on the chart might help you read the signals that the market is sending you now. Is the bearish or the bullish market coming? Find out!
Trend reversal patterns are patterns on the chart that precede the beginning of a new trend in the asset’s price direction, effectively ending the existing trend. A reversal can occur in an upward or a downward direction. In an uptrend, a trend reversal pattern can predict a bearish market, and vice versa; in a downtrend, a trend reversal pattern will most likely predict a bullish potential.
Being able to spot a trend reversal on the chart is an important skill because it allows traders to exit or enter the market in a timely manner and protects profits or stems losses. Plus, if you get the information about trend reversal early, you can make more profit from trading in the opposite direction.
Now, before we dive into covering the most popular trend reversal patterns in an attempt to not only educate you but also consider the best possible points to open a position, here’s one last thing to mention. However alluring it might seem to make a decision based upon a chart pattern you think you see amidst the price waves, always ask yourself first, is it really a pattern or is it something that you just want to see?
One of the most popular chart patterns out there is, hands down, Double Top and Double Bottom. We’ll discuss it in a minute, but it’s important to note that when talking specifically about this pattern, you should remember: the further apart in time the tops and bottoms, the stronger the pattern is.
Double Top is a strong bearish pattern in the shape of an M letter that is often formed after an uptrend. The price of the asset rises to a high, rebounds and then hits another high, building two tops. The corresponding highs act as a resistance level, the neckline acts as a support level. When the price of the asset goes down after hitting the second top and breaks the neckline, it means that there’s a high probability that you will see the M-shaped figure on the chart in full and the bullish trend will reverse to a bear market. Because this pattern often takes place after an extended bullish trend.
On the chart up above, we can see a possible point for opening a short position. This is the lowest price value after the retest, which is often considered a second confirmation of the bearish trend.
If you do manual trading, remember that the further apart in time the tops and bottoms, the stronger the pattern is.
Double Bottom is a strong bullish pattern in the shape of a W letter that is often formed after a downtrend. The price of the asset drops to a certain point, rebounds and hits another low at approximately the same price level. The corresponding lows act as the support level, the neck forms a resistance level.
This pattern often takes place after an extended bearish trend.
On the chart up above, we can see a possible point for opening a long position. This is one of the lowest price values after the retest, which, again, is always considered a confirmation of the reversing trend.
Head and Shoulders pattern is considered one of the most reliable patterns in terms of predicting the reversal of trend. Whether we’re talking about a bearish or a bullish pattern, it is always formed out of the same parts: the left shoulder, the head and the right shoulder.
The difference lies in how those parts are placed in different markets: with the upcoming bearish market, the pattern is upfront, with the upcoming bullish market, it is inverted.
It’s important to note, though, that the Head & Shoulders chart pattern is most often seen in uptrends.
The Bearish Head and Shoulders pattern starts forming when the price of the asset rises to a peak and declines back to the base of the prior up-move. After bouncing back off the base, it rebounds even higher than the previous peak and forms the “head” to later drop to the original base.
If you take a look at the chart up above, you will see that traders might consider entering a short position after the support line is broken. The risks lie in a chance of a false breakout and the formation of a bear trap.
On the chart up above, you don’t see the figure form a retest line next to the head and shoulders pattern. However, some traders prefer to wait until the price bounces back up to the neckline levels after the breakout and then starts dropping again. This would be a confirmation signal, and in this case, you can set up a stop loss slightly lower than in the previous case.
The Bullish Head and Shoulders pattern, also called an inverse Head and Shoulders or a Head and Shoulders bottom, often gets enforced with a decrease in volume during the formation of the head and then the right shoulder. The price falls to a low, rises again to the base of the prior down-move and then draws a deeper trough to fall again but not as far as the second trough.
Look at the chart. Basically, you could have entered during the formation of the right shoulder, but it’s safer to wait for the breakout of the neck line. Place a Buy Limit Order and a Stop Loss Order can be set at or just above the lowest point of the right shoulder to reduce possible losses.
What’s interesting about rising and falling wedges is that the confirmation for the change of trend here is an increase in trading volume around the point where channels should collapse. And it doesn’t really matter whether we’re talking about Bearish or Bullish Wedge. It works for rising and falling wedges.
Look for a rising wedge indicating a bearish reversal during a clear uptrend movement. The highs are getting lower and lower, and the lows are climbing high over the chart. The result is that the price appears to be squeezed between two narrowing ascending channels. The sharp impulse and a break through the support level should normally follow to indicate a change of trend. One more indicator that confirms the formation of the figure is that the breakout is characterized by the increase of the trading volume.
What can traders do in such a situation? Short positions are good to open when the support level is broken. Don’t forget to set up a stop loss order either above the support level or at the upper resistance level of the rising wedge.
Now, when you see a price fluctuating between two narrowing descending channels and forming a descending wedge as a result, it’s an indicator of an upcoming bullish reversal in a bearish market. But if the situation occurs in the bullish market, it’s an indicator of the general trend continuation.
In order to draw the figure right, it is necessary to build a tapering channel with lower highs and lower lows. The rising wedge figure is forming right when the price gets squeezed in the channel, and then a sharp impulse and a breakout follows. Just like with the previous figure, when trading volume increases, it’s a confirmation signal that the chart pattern is forming.
Where can you open a long position? Most likely, at a breakout from the channel. But remember to set a short Stop Loss below the channel’s resistance level in order to avoid losses in case of a false breakdown.
Trend reversal patterns are patterns on the chart that precede the beginning of a new trend in the asset’s price direction, effectively ending the existing trend. That said, depending on the market, those patterns can be upfront or inverted, bullish or bearish.
Double Top is a strong bearish pattern in the shape of an M letter that is often formed after an uptrend. Double Bottom is a strong bullish pattern in the shape of a W letter that is often formed after a downtrend.
Head and Shoulders is considered one of the most reliable patterns in terms of predicting the reversal of trend.Whether we’re talking about a bearish or a bullish pattern, it is always formed out of the same parts: the left shoulder, the head and the right shoulder. The difference lies in how those parts are placed in different markets: with the upcoming bearish market, the pattern is upfront, with the upcoming bullish market, it is inverted.
Look for a rising wedge indicating a bearish reversal during a clear uptrend movement. The highs are getting lower and lower, and the lows are climbing high over the chart. Now, when you see a price fluctuating between two narrowing descending channels and forming a descending wedge as a result, it’s an indicator of an upcoming bullish reversal in a bearish market.
Sounds difficult and challenging to remember? However, a skill of reading these patterns right helps understand which signal the market is sending you now, and it’s important to at least be aware of them.
Still, if you don’t feel like spending too much time on learning all about trading and technical analysis, maybe the right move would be to shuffle off this task to trading crypto robots.
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FAQ
What is a trend reversal pattern?
Trend reversal patterns are patterns on the chart that precede the beginning of a new trend in the asset’s price direction, effectively ending the existing trend.
How do you predict trend reversal?
In an uptrend, a trend reversal pattern can predict a bearish market, and vice versa; in a downtrend, a trend reversal pattern will most likely predict a bullish potential.
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