Forex Technical Analysis: Potential Reversal vs. Actual Reversal

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Potential Reversal vs. Actual Reversal

There is a difference! Potential reversal only tells us that there are indications that a trend change has a higher likelihood of happening than it did before. Actual reversal tells us that there are indications that the trend has already changed and so our directional focus should change with it.

So, what are the differences?

There are numerous indicators to inform us of potential reversal. We can use momentum indicators, volume indicators, charting patterns or candlestick formations, actually too many to discuss in this post, so I want to focus in on the chart pattern that is forming on the weekly AUDUSD.

The AUD has been in an uptrend for, well, a few years. The current leg began in May of 2010. That being knows there is an obvious tendency to focus on the upside and forget about the potential that is could and will eventually have a pull back. So there needs to be vigilance when looking for potential market change.

This week the pair is retesting the last high that it made in May of this year near the 1.1000 price level. (See chart below) This retest gives us an opportunity to realize potential reversal indicated by a double top charting pattern. A charting pattern is simply a grouping of candles that points to a particular outcome. The double top tells us that there is a high probability of reversal with low risk and high reward potential.

The opportunity comes for the sellers as close as possible to the 1.1000 price to get in at the beginning of what could end up being a change in the trend.

So what would be an actual reversal? Within the current uptrend we can define it simply as higher highs and higher lows. We can visually represent this using a trend line. To define a reversal we simply need to see the opposite of this definition, lower lows and lower highs. This means that to confirm reversal we will look for breaks of the former lows and supports as it breaks and follows through on the opposite side of the trend line. And since this is a weekly double top it may in fact take weeks before we can really know if this is a true reversal or just a false indication.

Couple these confirmations with multiple indicators like moving averages and smaller timeframe trend breaks and indicators will increase your confidence in the overall expectation of the trade opportunity.

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