How to Protect Your Trading Account From Crashes Due to Price Reversals

Neither roads nor markets move in straight lines. They both have signs indicating directional changes ahead. But the signs do us little good if we fail to see them or don’t know how to read them.

As drivers AND traders it is our responsibility to pay attention to the signs and adjust our driving or trading to the directional changes to come.

Things happen fast on the highway and in the markets. Sometimes, we become distracted and miss the sign of an approaching change in direction.

Sometimes being distracted is just inattention. Sometimes, it is understandable. Either way, the danger to our cars or trading accounts remains the same. If you fail to see the warning signs, damage to your car or your trading account can result.

At least with your car, there is insurance to pay for the damage.

When it comes to your trading account, you HAVE to keep your eyes on the market signs and not on the red Ferraris. Otherwise, you could be footing the bill for some serious trading losses.

What Causes Reversals In Roads And Markets?

Civil engineers, urban planners and politicians all have a hand in deciding the twists and turns of any roadway. All of these widely varied interests can make directional changes unpredictable.

Sometimes the markets can seem just as unpredictable.

On the road, we really have no reason to care why the direction is about to change…as long as we know it is and in what direction. In the markets, it helps to know why the direction is changing as well.

One of the most dramatic examples of these directional changes is a 180-degree reversal.

A market price reversal is exactly what it sounds like it would be. The market is heading one way and then appears to suddenly turn without warning and head in the opposite direction.

How Can We Tell These Reversals Are Coming?

Reversals in roads can occur in different directions and are indicated by signs that are mirror images of each other. On one, the direction arrow would be to the left. On the other, it would be to the right.

Traders need to be aware that reversals can occur in both upward and downward trending assets. The signs look similar except the key exhaustion in activity occurs on opposite sides and ends of the candlestick.

When the selling pressure is beginning to exhaust itself and an upward reversal is imminent, we can expect to see the inside of a candlestick that shows decreasing orders being executed on the BID side of the bottom of the stick. The last three consecutively lower prices show that the selling pressure is quickly evaporating to only 39 contracts being sold at the bid price at the lowest level.

The signs for reversals to the downside are found at the top of a rising candle (green) with the imbalance on the ASK side. The numbers will show the ASK orders executed falling significantly at the very top of the candle as the ASK price rises.

The two signs show the same thing except the data is diametrically opposed.

The same is true of the actions we will wish to take in each case to protect ourselves.

In both of these situations, the signs of reversals warn us to close our trades that were taking advantage of the existing trend.

Existing technology allows us to see the trading action taking place inside each stick of a candlestick chart.

How Do We Profit From Reversals?

Knowing how to identity coming changes in price direction is nice. It helps us avoid experiencing “fender benders” in our trading accounts through the signs of coming reversals. What’s next?

Profits! The term reversal doesn’t mean stop. It means to move in the opposite direction. Therefore, if the previous trend is exhausted, we should be able to make money on the assets as the opposing trend takes over.

That is the secondary opportunity provided to us by price reversals. To take the opposite side of the positions we just closed.

When the reversal is fully in place, we can continue to generate profits by taking the trade in the opposite direction of the one we just exhausted.

How Do We Protect Ourselves When We Are Wrong?

Once the signs of a reversal have signaled us to exit a position, our only remaining risk would be in a decision to trade the reversal in the opposite direction.

There is no market indicator that works all the time. Therefore, we always want to have an effective exit strategy for any position. When we enter an order to play a reversal trade, it is normally a good idea to use a protective stop.

These can be set somewhere around the previous high or low of the asset to protect your trading account from losses if we are wrong and the reversal doesn’t hold.

Road Signs Help Avoid Losses — Market Signs Do That And More

Unlike the highway warning signs supplied by the government, we create our own warning signs to protect our trading accounts. With today’s technology, it sounds more difficult than it is.

Our signs not only help us avoid crashing our trading accounts; they also help us increase profits by showing us when to add another leg to our trade.

If you choose not to use the tools available, who will be to blame when your trading account ends up in a ditch because you didn’t see the warning signs?

Don’t be that guy.

Noft Traders offers a Funded Trader Program. To learn more, visit their informational page at NOFT-Traders.com.