When a trend reverses, it can happen in a number of ways. It could simply turn around, without any warning. In most instances a parabolic price run up is needed, something that does not take place too often or truly major fundamental news must hit the wires.
Most of the time, though, price action provides some clues that the trend could change soon.
Market movements
Head and shoulder pattern, the crown and their derivatives are among the most well know reversal patterns and cover a broad range of shapes the price makes when direction is about to change.
On occasions, though, market movements are simpler and do not fit into any of these formations. They simply fail to make a new high/low, after which a reversal takes place. In a basic form, this is called a 1-2-3 pattern. As the name implies, it only has three components. I call it the “End of the trend” strategy.
For this formation to develop there must be a trend present. In an uptrend, the market makes a new high (1), followed by a pullback (2). This correction establishes a minor low. Then the price makes another attempt to make a new high (3), but fails, the price reverses and falls under the just formed minor low, which is a sell point, in anticipation of more downside.
The opposite happens in a downtrend. A new low is established (1), followed by a correction (2) and a failed attempt to make a new low (3). When the price moves above the just created minor high (2), a buy order is executed. The set up is very simple and straightforward. More importantly, it is easy to identify while forming, happens often and is present on all time frames.
Here is an example of the “End of the trend” strategy (or 1-2-3) on a 15M chart of GBP-USD. After a downtrend, the price makes a new low (1), bounces (2), and then fails to reach another low (3). This sets up a reversal, pushing the price way above the minor high (2), where the buy point should be.
RSI indicator
The RSI indicator is used as a filter, or a qualifier for the set up. In order to cut down on false signals, one wants to see the original low (or high), which starts the set up (1), to happen when the RSI is oversold (overbought for a sell). Any other indicator could be used, but the RSI seems to work well for the purpose.
What is the objective for this strategy? Number of approaches can be employed. One of them is the use of Fibonacci projections. The 100% extension of the distance between (2) and (3), past the buy/sell point seems to be working well.
In other words, number of pips between pints (2) and (3), then added (for a buy) or subtracted (for a sell) from the entry point, provides the trade objective. This is demonstrated on the 1H chart of AUD-USD.
With some practice, the “End of the trend” strategy is easy to identify and implement, has a short learning curve and is surprisingly effective, considering its simplicity.