How to Trade by Reversal Strategy

One of the main tenets of technology analysis is “the trend is your friend”. Therefore, some insist that for better results, trades should be carried out only following the trend. But every trend will eventually come to an end. The uptrend ends and changes or the downtrend and vice versa – see some examples in the chart.

The strategy we will discuss in a moment is called reversal. The name explains that traders should wait for the end of the trend and enter the market in the opposite direction. The time frame is H4, which means the strategy does not require much time in front of the computer to track prices.

The author notes that this method is quite easy to use, and the rules of risk management allow placing stop losses much lower than take profits. In this article, we will see how to use the ZigZag and MA indicators to spot the end of a trend and jump into a new trend.

Prepare indicators for strategy

This method is only valid for two currency pairs: EUR/USD and GBP/USD. It is a popular instrument today; also, the movement of GBP/USD will be the strongest. To start trading, two indicators need to be added to the chart:

Let's go over each of these indicators to better understand the reversal strategy. While MA is basically a basic tool that every trader is familiar with, ZigZag is not widely used.

Simple moving average

This procedure is based on the signal given by the SMA. It is very easy to use: when the price is above the indicator line, it is a buy signal. And when the price breaks the line from above, look for a sell signal. As a rule, this indicator is used in any trend strategy.

zig Zag

This indicator is usually used as a complement to Elliott Waves. This smoothes out some of the market movements and eliminates only minor fluctuations. Also, indicators help to eliminate the factor of subjectivity completely: it's no secret that different traders may evaluate the same chart differently. However, with ZigZag, the charts show clear extremes, making finding patterns and price levels easier.

Now let's add an indicator to the chart. Fortunately, both are available for popular trading strategies. On MetaTrader 4 they are added this way:

How to buy with a reversal strategy

After adding all the instruments to the chart, let's look at the details of opening long positions:

1. Value ZigZag from the bottom to the outside. Indicators help determine key levels on the chart. If indicator readings hit lows, a good recovery to the upside will follow.

2. The price broke the SMA upwards. Look at the closing price of the candle: if the price turns out to be above the MA, the breakaway is correct, allowing a buy trade to be opened when the next candle opens. This is the second signal of the strategy, which is necessary to avoid entering the market at the lowest point indicated by ZigZag. When the price breaks the MA from below, it is a signal to start an uptrend.

3. Place a stop loss 50 points from the entry point. In most cases, this will be below the local low indicated by ZigZag.

4. Place Take Profit at a distance of 150-200 points. As long as a trader enters the market at the start of a new trend, the moves can be very strong, which is why the profit size is so impressive.

Example of buying with strategy

As an example of a long position, let's take the EUR/USD chart from May 16, 2022.

ZigZag shows 1.0349 low. This is the first signal to open a buy trade. After reaching this low, the price actually started to rise. Now let's look at the second indicator.

The price broke the SMA (18) from below at 1.0434. Note that this line has been tested several times, but the price has bounced twice. Buy trades should be opened at the beginning of the next candle at 1.0430.

Place a stop loss at 1.0380, which is 50 points below the entry point. It is below the SMA line but did not reach the ZigZag low. However, a return of the price below the SMA will most likely invalidate the signal, making the SL plausible.