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80% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you can afford to take the high risk of losing your money. *CFD trading via Plus500’s demo account.

Trend Trading vs Reversal Trading (2024 Review)

Trend Trading vs Reversal Trading (2024 Review)

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80% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you can afford to take the high risk of losing your money. *CFD trading via Plus500’s demo account.

Success as a trader largely relies on the strategy that you follow. Trend trading and reversal trading are two well-recognized methods that many traders take advantage of in their approach to the wide range of trading opportunities.

Trend trading seeks to analyze the direction of the price of an asset or market and take advantage of it. This overall direction is called a trend, whether upward or downward.

When the trend is upward, trend traders may take a long position and ride the upward trend in price. When the trend is downward, trend traders will generally take a short position, selling before the price falls too greatly.

A trend trader may even buy or sell while the trend is still operating in their favor if they feel that the trend may change direction.

Reversal trading, by contrast, analyses and seeks to take advantage of changes in the direction of a trend. A change in the trending price direction is called a reversal.

Reversal trading carries a higher level of risk, however, as it relies on predicting when a true reversal will occur, as opposed to a pullback.

A pullback is a change in the direction of the price – for instance, down in an upward trend – that does not affect the overall trend. You may also hear the term ‘retracement’. This is synonymous with a pullback.

A reversal trader will generally wait to identify a reversal before they buy or sell, meaning that their trade happens after the change in direction has occurred.

With the first of the above strategies seeking to follow the trend and the second acting against the trend, it might seem that using one would exclude the use of the other. However, the methods of trend trading and reversal trading can be complementary when seeking success as a trader.

If you are interested in trading but want to learn more first, try one of these best day trading courses.

  1. Pepperstone
  2. Plus500
  3. eToro
  4. IG
  5. AvaTrade

1. Pepperstone

Pros

  • Extensively regulated
  • No minimum deposit
  • Low fees and mostly free withdrawals
  • Good customer service

Cons

  • No investor protection for clients outside UK, EU and EEA
  • Withdrawal fee for clients outside EU and Australia
  • CFDs only

Pepperstone is a versatile broker that supports both trend trading and reversal trading strategies, providing the necessary tools and platforms to execute these approaches effectively.

Pepperstone offers a wide range of tools and indicators suitable for both trend and reversal trading. For trend trading, traders can utilize moving averages, trend lines, and momentum indicators like MACD and RSI to confirm trends and decide on entry and exit points.

For reversal trading, tools such as candlestick patterns, oscillators like the RSI and Stochastic Oscillator, and divergence indicators are crucial. Fibonacci retracements also help identify potential reversal levels. These tools are available on all of Pepperstone’s platforms, ensuring traders have the resources needed for comprehensive market analysis.

Pepperstone supports trend and reversal trading through its advanced trading platforms: MetaTrader 4 (MT4), MetaTrader 5 (MT5), and cTrader.

These platforms offer robust charting tools, multiple time frames, and a wide range of technical indicators that cater to both trading strategies. MT4 and MT5 are renowned for their user-friendly interfaces and automated trading capabilities via Expert Advisors (EAs), while cTrader provides intuitive design and advanced order management features.

Additionally, the integration with TradingView offers powerful charting and social trading features, beneficial for identifying both trends and reversals through technical analysis and community insights.

Effective risk management is crucial for both trend and reversal trading, given the different risks involved in each strategy. Pepperstone offers several risk management tools, including stop-loss and take-profit orders, which are essential for protecting profits and limiting losses in both trading styles.

Pepperstone provides extensive educational resources that benefit traders using both strategies. Webinars, tutorials, and market analysis help traders understand market dynamics and develop effective trading strategies.

These resources are valuable for both trend and reversal traders looking to improve their skills and stay informed about market trends.

Visit Pepperstone

75.2% of retail investor accounts lose money when trading spread bets and CFDs with this provider.

2. Plus500

Pros

  • Regulated by the Financial Conduct Authority
  • Over 2,500 significant financial instruments
  • Negative balance protection
  • 24/7 customer support

Cons

  • Not currently available to US clients
  • No API integrations
  • CFDs only
  • No social copy trading

Regulated: Three tier-1 – UK, Singapore, Australia
Minimum deposit: $100
Costs and fees: Free withdrawals, overnight funding fee, currency conversion fee, inactivity fee, guaranteed stop order fees
Educational resources: Basic videos and articles, pdf
Demo account: Yes
Social copy trading: No
Customer service: 24/7 support through email, live chat and WhatsApp

Plus500 was founded in Israel in 2008; therefore, while it is regulated, it has yet to survive a recession.

The educational resources are not as good as other forex brokers, and the platforms lack when it comes to research and analysis.

It is user-friendly and easy to set up an account, however.

Beginners are always advised to start with a demo account since trading CFDs is a risky activity, Plus500 is not suitable for pure beginners.

Visit Plus500

80% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you can afford to take the high risk of losing your money. *CFD trading via Plus500’s demo account.

3. eToro

Pros

  • Regulated by FCA, ASIC
  • No withdrawal fee for US clients
  • 0% commission on stocks
  • Social and copy trading

Cons

  • Not available in every US State
  • More expensive than most of its competitors
  • No MetaTrader platforms

Below content does not apply to US users.

Regulated: Two tier-1 regulators – UK, Australia
Minimum deposit: $200
Costs and fees: Low forex fees, $10 per month inactivity fee, $5 withdrawal fee, additional fees may occur for some trades
Educational resources: Basic education videos, integrated educational content, YouTube channel
Demo account: Yes
Social copy trading: Yes
Customer service: Live chat, web-based ticketing with email replies

eToro is one of the most popular forex brokers in 2021.

For beginners, there is very little educational material to guide you, however.

Where eToro does excel for beginner traders is their social trading, which allows you to copy another trader's portfolio.

The trading platforms are also user-friendly.

To find out more, read our eToro review.

Visit eToro

76% of retail investor accounts lose money when trading CFDs with eToro. You should consider whether you understand how CFDs work, and whether you can afford to take the high risk of losing your money. Don’t invest unless you’re prepared to lose all the money you invest. This is a high-risk investment and you should not expect to be protected if something goes wrong. Take two mins to learn more.

4. IG

Pros

  • Highly regulated
  • MetaTrader 4 (MT4)
  • Over 10,000 instruments
  • Available in the UK and US
  • 24/7 customer support

Cons

  • High fees
  • No deposit compensation scheme for US accounts
  • No copy trading
  • Inactivity fees

IG is a great share trading platform for beginners thanks to its user-friendly interface and extensive educational resources.

Pros of IG include a wide range of trading instruments and markets, as well as the ability to access multiple account types and trading platforms. The platform also offers a demo account for beginners to practise trading strategies before investing real money.

However, IG isn’t the cheapest share trading platform, with relatively high trading fees and a minimum deposit requirement of £250 when paying by credit/debit card or PayPal.

In terms of additional fees, IG charges a commission fee for share trading, starting from £8 per trade. There’s also a custody fee of 0.25% per year for holdings of £250 or more.

Overall, IG is a solid choice for beginners looking for a user-friendly platform with extensive educational resources, but investors should be aware of its fees and minimum deposit requirements.

Visit IG

Spread bets and CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 71% of IG retail investor accounts lose money when trading spread bets and CFDs with IG. You should consider whether you understand how spread bets and CFDs work, and whether you can afford to take the high risk of losing your money.

5. AvaTrade

Pros

  • Highly regulated
  • Free deposit and withdrawal
  • No commission
  • Low minimum deposit
  • Social and copy trading

Cons

  • Not available for US clients
  • Inactivity fees

AvaTrade is a CFD Regulated broker with +1,000 financial instruments and multiple trading platforms. It has been operating since 2006.

It offers a 20% welcome bonus up to $10,000, according to regulation and a free 21-day demo account with $100,000.

Instruments include:

  • Metals
  • Commodities
  • Stocks
  • FX Options
  • Oil
  • ETFs
  • Options
  • Crypto currencies
  • CFDs
  • Indexes
  • Shares
  • Spread betting
  • Indices
  • Forex
  • Bonds

AVATrade EU Ltd is regulated by the Central Bank of Ireland. (No.C53877) Ava Trade Markets Ltd. is regulated by the B.V.I Financial Services Commission. It is also highly regulated in Australia, South Africa, Japan, Middle East, Cyprus and Israel

You can not trade with AvaTrade in the US, North Korea, New Zealand, Iran or Belgium.

Mínimum deposit of $100, no withdraw limit and no fees.

Visit AvaTrade

Benefits of Trend Trading

While the two strategies can work well together, it can be simpler to use just one. Trend trading alone does have certain benefits.

Stability

Trend trading is generally seen as a safer approach to trading because it follows the direction of the market.

Once a trend has been identified, the trader can usually predict how that asset or market will perform in the near future. There may be fluctuations in price, but the overall trend will continue in the same direction.

The challenge is to analyze whether a trend is likely to persist, using methods like trendlines, moving averages and the relative strength index (RSI).

Lower Risk

Trend traders know what to do once an asset or market begins a recognized downward trend – sell. The level of risk is lowered because they follow reasonably predictable market trends.

Having ridden an upward trend, possibly from its beginning, the trend trader can safely sell at the beginning of a downward trend and maximize their profits.

More Common/Higher Probability

Trends tend to be long-lasting whereas reversals, by comparison, are much rarer. This means that a trend trader has more opportunities to take advantage of than a reversal trader.

Add to this the fact that trading with the trend provides a higher probability of success, and trend trading begins to look like the best option.

If you want to learn about the risk involved in trading stocks and shares, you can learn about it here.

Benefits of Reversal Trading

Trend trading seems like a better option at first glance. But reversal trading also has many benefits – larger profits for one.

Get in at the Start

The focus of reversal trading is to carefully monitor the markets for indications that the price of an asset or market is likely to change direction. This knowledge provides you with an opportunity to jump on trends from the beginning.

If the trend is upward, you will be able to buy low and then ride the rising price until the trend changes. If the trend is downward, you can sell your stock, forex, cryptocurrency (for example, [Bitcoin]/trading/cryptocurrency/learn-to-trade-bitcoin)) or asset before the price drops any further.

The ability to react to a trend at its beginning will increase your likelihood of making a higher profit from your trading.

Higher Risk to Reward Ratio – Better Profits

The risk-to-reward ratio compares how much money the trader is putting at risk when making a trade with how much return (reward) that trade may earn. For example, if you risk $500 for a possible $3,000 return, that is a 1:6 ratio.

Generally, a risk-to-reward ratio minimum is accepted as 1:3. A ratio that is higher than this offers higher rewards but also a higher risk.

In reversal trading, the risk-to-reward ratio is higher than if you follow the trend of your asset or market. This means that the return on your trades is likely to be higher, thus cushioning any losses you may make.

More risk, but greater rewards make reversal trading an exciting way to make money.

Good Addition to Trend Trading

As mentioned at the beginning of this article, it is not necessarily a case of being a trend trader or a reversal trader. The two strategies can, in fact, complement each other.

Trend trading is reliant on following a trend until it no longer serves your purposes. In other words, once the trend heads downwards, the trend trader sells.

The methods used to predict a reversal, the change in direction of a trend, can be a useful aid to a trend trader’s ability to predict market trends.

Limitations of Reversal Trading

Reversal trading’s limitations are based on the nature of reversals themselves. Initially, it can be difficult to tell whether an apparent change in direction of the price of a market is a true reversal or simply a pullback.

Once it becomes clear that a reversal has occurred, the price of the market may already have altered drastically. In the case of a reversal into a downward trend, the price may have fallen a sizeable amount. In a reversal into an upward trend, the cost to buy may have risen to a level that makes it a less profitable prospect.

The methods used to predict a reversal may also work against the trader because one method may indicate the likelihood of a reversal whereas another will not. Reversal trading relies on successfully using several methods and interpreting their results as a whole.

Trend Trading vs Reversal Trading
Trend Trading vs Reversal Trading

IG

How to Identify Reversals

Whether you use reversal trading as a lone strategy or to inform trend trading, you must learn how to identify when a reversal will happen.

Many methods can be used together to build a more detailed answer to the question, ‘Will this market trend reverse soon?’

Before looking at each of these methods, it might be useful to examine how trendlines enable a reversal trader to identify the direction of a trend and its developing upper and lower limits.

Trend Trading vs Reversal Trading
Trend Trading vs Reversal Trading

In the simplified diagram above, the black line shows the price of an asset, or market overall, increasing and decreasing. As you can see, it is not a steady rise or fall but a progression of price changes.

The trend is identified by finding the highest and lowest points of the price’s oscillation and examining their direction. These are indicated by the two orange lines.

If both of these are increasing in price over a decent period, the trend is upward. If both, instead, are decreasing, the trend is downward. In an upward trend, the terms used are high highs and high lows. In a downward trend, they are called low highs and low lows.

To predict a reversal, the behavior and extent of the oscillations in price in relation to the accompanying trend can be analyzed in several ways:

Bounce Failure in Trend Line

A ‘bounce’ is the price’s journey up from the bottom trendline. In a downward trend, this is called a ‘dead cat bounce’. A bounce’s real value as an analytical indicator is in an upward trend.

When the price of a market or asset creates a new high low, it will touch the bottom trendline. If that action then rises to create a new high high, this is called a bounce.

A bounce does not have to go straight from a high low to a high high, but it should continue in that general direction. There are two bounces in the above diagram – one at the beginning and one around three-quarters along.

Should the price rise from a high low but not create a new high high before falling again, this is a bounce failure.

Pullback or Retracement

A pullback or retracement is a change in a market price’s direction that is opposite to the overall trend. Alone, a pullback will not change the direction of the trend but the pattern in the size of successive pullbacks may indicate that a reversal is likely to happen.

For instance, in an upward trend where the size of pullbacks grows larger with each occurrence, the momentum of the upward direction appears to be slowing and the possibility of a reversal, a change to a downward trend, is increasingly likely.

Trend Waves

A trend wave is an extension from a high low to a high high in an uptrend or low high to low low in a downtrend.

Where the size of those trend waves is steadily decreasing, this is an indicator that a reversal is likely to happen.

Trend Structure Change

In an upward trend, there are high highs and high lows. In a downward trend, there are low highs and low lows. These form the structure of your trend. But that structure may unexpectedly change.

For instance, in a downward trend, the price of your market is reliably hitting those low highs and low lows. But it may hit a new high low.

Equally, an upward trend could suddenly result in a low low.

Either of these would indicate that a trend reversal is on the way.

Cross-Check with Current Events

This is a different kind of tool but one that can be useful in predicting the likelihood of changes in the financial markets.

Take the example of the Covid-19 pandemic:

  • General spending slowed as consumers worried about the security of their jobs and many found themselves out of work.
  • Combined with consumers’ financial worry, lockdown and social distancing meant less leisure spending, whether goods, services or locations to visit.
  • Tech stocks benefitted from the move to working from home and the use of online connection and entertainment, such as the uptake of video conferencing for work meetings and family catchups.
  • The commodities market became increasingly volatile, for instance, agriculture experienced initial losses but later recovered.
  • Taking advantage of plunging prices, a whole host of first-time investors came on-board, bringing new money and eyes to the markets.
  • Even though there was a dramatically increased need for hospitals, many health-related stocks dropped in price as hospitals and clinics braced themselves for the impact of the pandemic and spent less as a result.

Knowing how specific brands and industries are performing in the real world can provide you with an indicator of how the related markets, be those shares, commodities or currency, will behave.

Frequently Asked Questions

Trend trading is a trading strategy that involves analyzing the price movement of an asset to determine its overall direction, or trend, and then making trades based on that trend.

In trend trading, traders look for assets that are moving in a consistent direction, either up or down, and attempt to profit from that trend by buying or selling at strategic points.

Reversal trading is a trading strategy that involves attempting to identify points at which a trend is likely to reverse direction, and then making trades based on that expectation.

Reversal traders look for assets that have been trending in one direction for an extended period and are nearing a point of exhaustion, indicating that a reversal is likely.

The main difference between trend trading and reversal trading is the direction of the trades.

Trend traders aim to profit from the continuation of an existing trend, while reversal traders aim to profit from the reversal of a trend.

To identify a trend in position trading, traders typically use technical analysis tools such as moving averages, trend lines and momentum indicators to analyze the price movement of an asset over a period of time.

Traders look for patterns that indicate a consistent upward or downward trend.

To find a reversal in trading, traders look for technical patterns such as trend line breaks, head and shoulders patterns, and divergences in momentum indicators.

They also look for fundamental factors that could cause a change in the direction of the trend.

To create a trend trading system for stocks, traders typically use technical analysis tools to identify trends and determine entry and exit points for trades.

They may also use fundamental analysis to identify stocks that are likely to experience sustained price movements in a particular direction.

To master trend trading, traders should study technical analysis and become familiar with the tools and indicators used to identify trends.

They should also develop a trading plan that includes specific rules for entering and exiting trades based on the direction of the trend.

The main indicators used in reversal trading are technical indicators that help identify patterns that indicate a potential trend reversal.

These may include moving averages, momentum indicators and pattern recognition tools.

The main risk associated with trend trading is that the trend may suddenly reverse direction, causing losses for traders who have taken positions in the opposite direction of the new trend.

There is also the risk that the trend may change direction gradually, resulting in losses as traders hold on to losing positions for too long.

The main risk associated with reversal trading is that the reversal may not occur, resulting in losses for traders who have taken positions in anticipation of a reversal.

There is also the risk that the reversal may occur, but the price may continue to move in the opposite direction for an extended period, resulting in losses as traders hold on to losing positions.

Reversal trading can be either a short-term or long-term strategy, depending on the time frame used to analyze price movements and identify potential reversals.

The best brokers for trend trading and reversal trading are those that provide traders with robust charting tools, real-time data and a wide range of assets to trade.

Some of the most popular brokers for trend and reversal trading include TD Ameritrade, E-Trade, Interactive Brokers and Charles Schwab.

However, it's important for traders to do their own research and compare the features and fees of different brokers to find the one that best suits their needs.

Final Thoughts

As a trader, having a keen eye on how the markets are performing is paramount.

If trend trading provides a relative safety net in its adherence to market momentum, reversal trading equips the trader with a way to predict changes in trend direction.

While either can be used as sole strategies in their own right, trend trading and reversal trading are most useful when considered together.

WikiJob does not provide tax, investment or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.

80% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you can afford to take the high risk of losing your money. *CFD trading via Plus500’s demo account.


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