How and When To Trade Trend Reversals Like AUD/USD's, Gold's, SPX's
- Calling a meaningful turn - where there is a significant move in an opposing direction - is one of the lowest probability trades
- Different risk tolerances allow for different degrees of confirmation and conviction; but consecutive series alone is not enough
- We take a look at the incredible runs from the AUD/USD, Gold and the S&P 500 with their differences and similarities
Reversals: they are the most attractive events in the financial markets for traders. In these events, we expect dramatic volatility for quick profits, distinct turning points for clear stops and wide targets for strong risk-reward. Yet, this combination of ideal circumstance is a rare occurrence. Meaningful turns in price that provide significant follow through pops up infrequently - otherwise the landscape would be one of extreme but consistent volatility. Clearly it is not. Given the infrequency of these opportunities, timing and conviction are of the utmost importance. Otherwise, we will be jumping into many false starts. If you depend on a strong winners-to-losers ratio, calling reversals is the best way to see your way out of the market. If the focus is on size of winners versus number, the emphasis on picking turns that never come to fruition is not as damning to your overall performance; but accuracy will always matter to some degree.
Risk tolerance is unique to each trader, so the effort to pick reversals is naturally personal. Personally, I am more conservative looking for a balance of number and size of winners; so I in turn require more evidence that markets are genuinely marking a turn before I attempt to trade the effort. And, given that there have been a number of one-sided moves in the financial system as of late; it should come as no surprise that there are a range of examples we can use to determine some of the criteria that can be used to weigh your interest in trading a turn or standing skeptically on the sidelines. Perhaps the most lurid signal of a turn that should be met with much more analysis is AUD/USD. Our attention was naturally captured by a record-breaking 13-day consecutive advance for this currency pair. Not only was that unprecedented, it naturally stands out as a statistically anomaly that will inevitably be pushed back to some 'normal'. Well, if that was the only criteria for calling a turn, it was already fulfilled as the market has retreated the past few days. That does little to suggest there is strong momentum behind to match the run up; and there isn't even much build up to reverse notionally. A statistical series like this is perhaps the weakest individual signal we can rely on for a trade setup.
Gold is of a similar cut. The commodity rose an impressive 8 straight sessions and then started to stall. Yet, an improvement over the currency pair; this market covered more ground and comes much closer to broader technical boundaries. That adds up to greater technical weight to work with. Yet, it too falls short when it comes to motivation for a lasting and profitable reversal. There is little fundamental drive whether it be 'risk on' or a strong Dollar motivation. That is not to mean there is not a trade here. It just should come with a more prominent motivation on the fundamental side - one that is not yet evident. Finally, we have the S&P 500. That doesn't even look like an attempt at a reversal because we haven't seen even a few days of correction. In fact, it is six days up consecutively and even more impressively 10 straight months of climb which is a record. Yet, the fundamental hallmarks of deviation from value, retreat in volume and growing concern over complacency are more distinctly fleshed out. And, clearly there is plenty of room for the pendulum to swing should it turn. In today's Quick Take video, we look at popular examples to discuss what makes for better timing and trading of reversals.
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DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.