Market reversals are a common phenomenon in the world of finance and investing. Let's dive into this topic to gain a better understanding.
What are Market Reversals?
Market reversals occur when the direction of an asset changes from an upward trend to a downward trend, or vice versa. These reversals can happen suddenly or gradually, and they often signal a shift in investor sentiment and market price rotations.
Types of Market Reversals
There are two main types of market reversals: bullish reversals and bearish reversals. Bullish reversals occur when a downtrend in the market shifts to an uptrend, indicating a potential shift in sentiment and price rotations. On the other hand, bearish reversals occur when an uptrend in the market shifts to a downtrend, signaling a potential decrease in price and shift in rotations.
Different Time Frame Reversals
Price reversals can occur in almost any given time frame from as small as a 1 min to daily time frame analysis. The key is understanding if the reversal is meaningful enough to expect a higher reward factor based on its overall time frame it is on and the amount of volume being transacted at the time of the reversal occurring.
Failed Breakdown / Breakout Reversals
By definition a failed break in price is when, the price of an asset moves beyond a known zone of support or resistance but then reverses course moving back above support or below resistance.
There are many ways traders identify failed breaks whether that is using trendlines - diagonal, chart patterns, I personally only utilize them in terms of horizontal zones.
A failed break in price usually has 2 main components, they must both exists in order to validate the strategy and the more prominent one of the components is the bigger the reversal.
Component #1 : The simplest way to identify if a move has failed is for price to break out form a swing high or low of a zone of interest in this case a known support / resistance and retraces back into the zone after having moved away and back into its previous range.
This price movement away and back into its range results in some breakout traders to become "trapped" or pushed out of the move as price fakes out and away from the newly form high or low.
Component #2 : Volume, volume, volume and volume... In order for any meaning break in price for a new high or low to be made there must be active participation to continually push price away from the balance of price. If new market participants willing to transact a lower or higher prices do not continue to hit the bid or offer then price will collapse into itself and mean revert to a level where market liquidity exists.
If price is moving out of a support or resistance on thin volume the probability of price mean reverting becomes relatively high. There is no easier way to identify thin volume being transacted during these kind of moves than with order flow tools that I cover in these posts.
This very metric can help us traders dictate the weakness of the move out of the range and its probability of breaking but also help identify how long the reversal itself can last.
If price reverses back in and volume kicks in on the move back to the mean it is highly probable the move will revisit the other end of the extreme of the range and potentially break out into the opposing side which can result in price continuing its macro trend or potentially revering course and forming a new macro trend.
Below is an example of a Failed Breakdown trade that from a candle stick chart in high sight looks to have been a buyable dip the problem is the candlesticks wouldn't not of shown you what is under the hood showing you the true mechanics of what the actual participation of buyers and sellers was during the break in price.
You have the break down of range from 5317 - 13 bears where able to push price down to new lows but as those lows where made the next illustration will show the actual strength the bulls showed swallowing up all the inventory of the net selling and absorbing this very sell returning price back into its previous range and ultimately touching and breaking past the high of the very range.
The foot print chart here shows the same lay of the land the previous illustration has with one key component shown which was the most valuable metric when gauging the quality of a failed break up or down strategy, VOLUME.
What is circled below shows the "thinness" of the candle indicating that the sell side was inactive while the red "91" delta indicating that all the net selling that resulted in that push down was absorbed and met with buying.
This then resulted in pricing revisiting the range low of 5313, where the profile became super "thick" and buying continued to out weigh all of the buying hence the blue "217" delta print which then resulted in buyers reclaiming control and pushing price into new highs out of the range.