If you are new to forex trading, then you will most likely be watching the trends or doing what experienced traders call trend trading. It’s the easiest way to enter into forex trading on a demo or live account. Mastering what trend reversals and corrections mean is crucial at this stage.
What Is the Difference Between Reversal and Correction/Retracement?
Trend reversal refers to a situation or point where the price trend changes in either direction. For instance, if the price changes from an uptrend and starts falling, then that is a reversal. On the other hand, corrections or pullbacks are more subtle temporary movements of the price opposite to the main trend.
If you are completely new to day trading, you are likely to confuse corrections or retracements with reversals which can lead to costly mistakes. A simple error of judgment or overreaction can be the difference between losing a lot of money or missing out on huge earnings. For example, you will likely end up wiping your whole trading account if you can’t catch negative reversals early or use stop losses.
Another key and important difference between reversals and retracements is duration. While reversals usually affect the larger trend and last for long periods, a simple correction is temporary and is not a reflection of the direction of the trend. Some reversals will go on for several hours, days, months, or even years depending on the currency pairs in question.
Should You Watch Out for Corrections or Reversals?
In most cases, you should only be worried about corrections or retracements if you are a day trader or have huge trading positions on a currency pair. A simple correction might likely lead to huge losses on your side so you need to keep an eye out for when they happen or manage risk. For instance, a single-digit correction on the price can mean losses in the thousands of dollars if that’s how much you have riding on the currency pair you are trading.
Long-term traders or those with long positions should only worry or keep an eye out for reversals and use the indicators, moving averages, and other methods to avoid a reversal plunging them into the abyss. Using a risk-management strategy in forex trading is crucial to prevent making big losses when a reversal that does not favor your position occurs.
How to Predict and Handle Reversals and Corrections.
There are several ways to predict or at least detect when a reversal or correction is about to occur in forex trading. However, for this guide, we’ll focus on two that we think are beginner-friendly. They include:
- Using Indicators- Technical Analysis
- Watching trend-reversal patterns
Using Indicators to Detect and Differentiate Reversals and Corrections
Technical analysis using available indicators is every forex traders go-to method when looking for reversals and corrections. However, it’s not always straightforward as reversals tend to occur without warning. After all, a reversal usually occurs in cases where there is a lot of sell or buy interest in the market which includes every other trader especially newbies.
You can use the moving average as a new trader to try and spot reversals early on. Watch out for when the price is climbing above the moving average below it and act accordingly. In most cases, you will have a personal risk appetite which determines how soon you act when this happens. For newbies, it’s always advisable to have as little risk appetite as you can and always act fast, taking whatever gains you have made.
Watching Trends and Reversal Patterns
Also important in beginner trend trading is watching the trendlines using candles and sticks and other charts you might be comfortable with. It’s possible to spot reversals by looking at the movements of the price and reading a trendline on the movement. For instance, when the price hits a new lower low on an uptrend, then it could be a subtle sign that there is a reversal about to occur.
Detecting reversals and corrections usually require some level of skill and analytical ability to do well. It is the very unpredictability of the market especially with reversals that determines who losses out and who makes a profit. As a beginner, it’s best to use a stop loss just to cushion your account against devastating reversals.