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Investing Articles

What is a Reversal?

One thing, which is as sure as death and taxes, is the term Reversal not meaning the same thing to every person. I get questions from time to time, especially after posting a reversal forecast, as to what those Reversals mean to us, the trader. Although this subject has been touched on several times in the past, I'll go over it again here for those not aware of this.

First, the term Reversal is self-explanatory. It simply means a "change in direction." If price is moving down and then makes a Reversal, we can assume it will then be moving up. The reverse goes for price that is moving up, as it will then move down following a Reversal.

Other terms for Reversal are Swing or pivot. They are pretty much used interchangeably. A Swing goes from up to down to up again, continuing in this pattern indefinitely. A Pivot can be likened to ones pivot foot in basketball, where you can pivot from facing one direction to facing the opposite direction.

The first thing to understand when we are discussing Reversals is this . . . "What is the Time Frame in question?"

You can have Reversals occur in any time frame. And just because it occurs in one time- frame, say a 5-min. chart, it does not mean that it will show up as a Reversal on a much longer time frame, such as a daily or weekly chart. So the first thing you certainly want to make clear is the Time Frame Reference for the Reversal.

Yesterday I posted a Reversal date for the S&P-500 market. The time frame in question is the daily time frame. On your daily price chart, you should note a bottom or top form for the Reversal date in question, followed by at least 2-price bars or more forming in opposite direction.

Example: Obviously we can see that on a daily price chart, SP-500 has been forming price bars with lower highs and lower lows the last couple of days. When one is expecting a Reversal for this market at this time, you would be looking for a price bar to make a lower low within a standard deviation of one price bar of this reversal date.

Following this price bar which forms a lower low, you would expect at least 2 or more price bars making higher lows then the newly formed Reversal bottom. The easiest way to visualize these Reversals or Swings is to learn how to plot a Swing chart. There are rules for one-day SC's, two-day SC's, and three-day SC's. When dealing with Reversal dates, you would want to use the one-day variety.

Say you have a daily price chart in front of you in paper form. If you were to take a pencil and draw lines from the very top to the first bottom, then up to the next top, then down to the next bottom and so-forth, you would in simplistic terms be drawing Swings or Reversal points.

One book I have come across which teaches how to draw swing charts is called "pattern, price and time Using Gann Theory in Trading Systems" available through Wiley Books. It is also taught in the time price trader available at http://fsoftpublishing.com

In short, as long as price bars form lower highs and lows, you continue to draw your line down to the most recent lower low. Once a bar forms a higher high and higher low than the bar preceding it, you then Swing up the line from that lower low to the new higher high. This process continues till end of your price data on the chart.

Those peaks you drew are the Swing or Reversal tops, and those valleys (or upside down peaks) are the Swing or Reversal bottoms. Therefore, when you have a Reversal date to work with, you are looking for the price bar that forms this Reversal or Swing to occur within a standard deviation of one price bar of that date. Therefore, going back to SP500 at the moment, since the price bars formed are making lower lows, we keep drawing a line downwards looking for the next Swing which can only be one thing, a swing bottom. Swings always alternate from bottom to top to bottom . . . and on and on and on.

 


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One final note for the less experienced in Reversal Date use. At times the market can quickly form a Swing top and then a swing bottom within just one-day of each other. You've seen this happen many times. Market makes a bottom, shoots up and makes a top the next day, then drops again like a rock. How would you decide on the swing associated with any Reversal date?

For one, if they both do not occur within one price bar deviation of the date, then only the swing that does fall within this deviation can be considered. If they both occur within this window (one on the very day and one is a day late . . . thus one standard deviation off), you would then employ other aids or stand aside. Such aids are moving averages, support/ resistance price zones, etc. This post will not be dealing with these aids, but it is worth a mention. Hopefully for those who were not clear as to what a Reversal is, this is now much clearer. Let me state that, when I deal with a Reversal Date, I'm not looking for an one-day swing. What good is that? It is expected that Reversal dates will produce swings followed by 2 or more price bars moving in the opposite direction. When this is with the trend, it is very useful.

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