One of the conventional strategies for traders is to watch out for a market making a top or bottom and then taking advantage as the trend reverses direction. A mistake that many novices make is to think that they must buy or sell at the point of reversal. In truth, no one can predict with any degree of certainty the actual point where the price reverses, and as long as you are alert enough to observe that a reversal has happened, and then place your trade, you will benefit from most of the move in a low risk way.
There are several ways that you can tell a reversal is likely, so that you can put the stock on a watch list. One way involves using technical indicators, which will signal if the stock is overbought or oversold and therefore prone to a price adjustment. Another way involves identifying significant levels of support or resistance, which are levels that have been tested in the past where the price has turned back. If they have been tested more than twice, then they are considered stronger. Thus, should a share price rise up to resistance and then starts to retrace it might be a good time to consider putting in a short.
In each case, you want to see that the price reverses back into the range it has been trading in before placing your trade. While stock prices can trade in a range for some time, eventually the pattern will break and the support or resistance line be breached, and you don't want to be on the wrong side of that trade.
If you are trading a security that is range bound between support and resistance, your potential profit is limited to that range. But if you choose a leveraged instrument, such as spread betting, then you can still find substantial profit even within the range. As your money is multiplied by the spread bet, the amount that the price moves is less important for profitability, and you can afford to wait until the reversal is clear.
Not all reversals happen from established support and resistance lines. For instance, there may be an uptrend which ventures into new price levels where there is no resistance established, but the trend may run out of momentum and result in a reversal, or sometimes a consolidation. It's normal for a trend to have some countertrend moves from time to time, as Elliott Wave Theory teaches us, and Fibonacci ratios can give us an indication of how far the retracement is likely to come before resuming the trend.
Finally, when thinking about reversals you shouldn't overlook the classic indications of a pending reversal. With Western charting, one of the most well known patterns is the Head and Shoulders, so-called because the price makes a three hump pattern with the middle (head) higher before reversing into a downtrend. A reversal may also be signalled by a Double Top pattern. With candlestick charting, there are many reversal patterns that have been identified and catalogued. A most basic indication is the presence of a Doji candle, which is one where the real body has no length showing that the opening and closing prices were the same for the session. This usually indicates indecision and a possible reversal in a trend.
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