What Is A Trend Reversal?
In binary options trading, the trend is your good friend: once you have spotted a trend, you can make nice profits riding it. But no trend lasts forever, a reversal can occur at any time. Your account balance will suffer if you do not recognize it in time, and continue to trade in the direction of the previous trend. By spotting trend reversals you can avoid losing money. Let’s take a closer look at it!
A trend reversal is a major change in direction, it is caused by a change of sentiment toward an asset. In an uptrend, the buying interest will be lower, this makes the price fall. In a downtrend, the selling interest will be lower, this forces the price to rise.
There are often fundamental factors behind a trend reversal. The change might follow the announcement of important news or economic releases. For example, when major economic indicators miss the expectations of analysts, a reversal might come.
How Can You Identify A Trend Reversal?
To be more profitable in binary options trading, you need to forecast changes in the price of the underlying asset. What tools can help you to decide whether the trend will continue or reverse direction?
Comparing volume with price
American journalist Charles Dow, founder of The Wall Street Journal and inventor of the Dow Jones Industrial Average researched trend reversals as well. He pointed out that price and volume move together: in a stable uptrend, volume increases constantly. A drop in volume is usually a signal of trend weakness and a possible trend reversal.
Using moving averages
Moving averages consider the closing prices of an asset over a certain period of time. A reversal occurs when the price moves closer to the moving average. The closer it gets to it, the more likely that the trend change comes. Traders use short-term moving averages such as the 20-period average and intermediate- or long-term moving averages such as the 50-period average or the 200-period average. The strongest indicator is the 200-day average, when the price crosses it, the trend has most probably changed.
Using momentum indicators
Momentum indicators measure the rate of change in closing prices, so they can be used to detect trend weakness and to find trend reversals. These kinds of indicators show whether an asset is overbought or oversold compared to the price range of the prior period. “Overbought” means that the price has risen too fast or for too long, therefore it is expected to move lower. On the other hand, the term “Oversold” refers to the situation when the price has fallen too fast or for too long, so is expected to move higher.
There are many momentum indicators, the most effective ones include:
• Moving Average Convergence/Divergence (MACD): this indicator is calculated by subtracting a longer-term exponential moving average (EMA) from a shorter-term EMA.
• Relative Strength Index (RSI), that measures the speed and change of price movements. It is considered overbought when above 70 and oversold when below 30.
• The Stochastic indicator compares the closing price of an asset to the range of its prices over a given period of time.