Reversal or pull back? Knowing whether the markets are about to change direction or are simply pulling back before continuing the trend is one of the hardest decisions a trader faces. Sometimes price simply pulls back and takes a breath before continuing. Other times markets reverse completely and its important we try not to be on the wrong side of these often wild moves.

This week, it seems as though we are staring down a lot of engulfing weekly candles.  So how do you know when to trust them??  I have a 3-step checklist I use to determine whether I consider a reversal candlestick formation valid or not.

1. Context:  The real question becomes, “is there a move to reverse?”  So often, we see engulfing candles right after sideways moves.  We also see them out of the blue.  The problem is that if we took every single one, it wouldn’t be as profitable as choosing select engulfing/reversal candles that have context.  There must be a move to actually reverse.  I consider at least 3 prior candles enough to establish a trend before the reversal.  On monthly though, we just need 2 prior months since that can cover so much of the market.  For a reversal candle to be valid, make sure there is the context of at least a move to reverse.

2. S/R Rejection:  The second check on the list becomes “did price reject a major area”.  Reversals work best when price fails (the more dramatically the better) to take a major area and close through it.  When we see rejection of a major area after an established move in the direction of it, we can see that the opposite side stands strong there and could reverse price.  If price simply rejects or reverses without this, it could simply be a small pullback that will continue the move later.  By ensuring we have rejected an area of s/r, we give ourselves a better chance of catching a legitimate reversal.

3. Valid Formation:  I know this may seem obvious, but it’s worth analyzing.  The question is “Is the candlestick a valid engulfing/pin bar/reversal?”  It is worth the time to sit and look at the candle itself.  If pin bar, does the body agree with the reversal?  If engulfing, does the body completely engulf the prior candle’s body?  Making sure you don’t just see a wick and decide it’s a reversal can save you from losing a trade.  After checking the first two items,make sure the reversal candle is actually a valid candle to qualify for whatever type its supposed to be.

By checking off these three points every time you look to trade a reversal formation, you will increase the chances it is valid and you can enjoy the ride well before others see the full reversal form. If you are unsure about how to interpret candlesticks, they are explained in greater detail here: Forex Candlesticks

If you would like to see the videos and learn how to trade forex using technical analysis, check out our 100% FREE Forex Training Course: CLICK HERE

Author: Marc Walton

Reversal Or Pull Back?