Every trend eventually ends, and being able to identify when a trend is about to reverse can be extremely valuable. Catching a reversal early allows you to exit existing positions before losses mount or enter new positions at the beginning of a fresh move. In this guide, we will explore the most reliable trend reversal signals that professional traders use.
Understanding Trend Reversals
A trend reversal occurs when the market changes direction from an uptrend to a downtrend or vice versa. This is different from a pullback or correction, which is a temporary move against the trend before it resumes. True reversals mark the end of one trend and the beginning of another.
Important distinction: Not every pullback is a reversal, and not every reversal signal leads to a successful reversal. Always wait for confirmation and use proper risk management when trading potential reversals.
Classic Reversal Chart Patterns
1. Head and Shoulders
The head and shoulders pattern is one of the most reliable reversal patterns. It consists of three peaks: a higher middle peak (head) flanked by two lower peaks (shoulders). The neckline connects the lows between the peaks.
Trading the Head and Shoulders Pattern
- Formation: Left shoulder forms, then a higher head, then a right shoulder at similar level to the left
- Neckline: Draw a line connecting the lows after the left shoulder and head
- Entry signal: Price breaks below the neckline with volume
- Target: Measure the distance from the head to the neckline, project it downward
- Stop loss: Above the right shoulder
The inverse head and shoulders pattern signals a reversal from downtrend to uptrend.
2. Double Top and Double Bottom
These patterns form when price tests a level twice and fails to break through, indicating that buyers (at resistance) or sellers (at support) are exhausted.
Double Top (Bearish Reversal)
- Price reaches a high, pulls back, then rallies to the same high again
- The second attempt fails to break higher
- Entry signal: Price breaks below the support between the two tops
- Target: Distance from the tops to the support, projected downward
Double Bottom (Bullish Reversal)
- Price reaches a low, bounces, then falls to the same low again
- The second attempt fails to break lower
- Entry signal: Price breaks above the resistance between the two bottoms
- Target: Distance from the bottoms to the resistance, projected upward
3. Triple Top and Triple Bottom
Similar to double tops and bottoms but with three tests of the level. These are less common but often more reliable because the level has been tested more times.
Price Action Reversal Signals
Break of Market Structure
The most fundamental reversal signal is when the pattern of higher highs and higher lows (uptrend) or lower highs and lower lows (downtrend) breaks.
Uptrend Reversal Structure
- Uptrend is in place with higher highs and higher lows
- Price makes a new high but then pulls back below the previous low
- This "lower low" breaks the uptrend structure
- If the next rally fails to make a new high (creating a lower high), the reversal is confirmed
Candlestick Reversal Patterns
Certain candlestick patterns at key levels can signal potential reversals:
- Doji: Shows indecision after a strong trend, possible turning point
- Hammer/Hanging Man: Long lower wick shows rejection of lower prices (hammer at bottom) or higher prices (hanging man at top)
- Engulfing patterns: A large candle that completely engulfs the previous candle in the opposite direction
- Evening/Morning Star: Three-candle reversal patterns at tops and bottoms
- Shooting Star: Long upper wick at the top of an uptrend shows rejection
Divergence: The Early Warning System
Divergence occurs when price makes a new high or low but a momentum indicator (like RSI or MACD) does not confirm it. This suggests the trend is losing momentum and may be ready to reverse.
Types of Divergence
- Bearish divergence: Price makes a higher high, but RSI/MACD makes a lower high. Warning sign in an uptrend.
- Bullish divergence: Price makes a lower low, but RSI/MACD makes a higher low. Warning sign in a downtrend.
- Hidden divergence: Confirms trend continuation rather than reversal (less common)
Example: Stock XYZ rallies from $50 to $60 with RSI at 75. It pulls back to $55, then rallies to $62 (higher high). But RSI only reaches 70 (lower high than 75). This bearish divergence warns the uptrend may be ending.
Volume Analysis for Reversals
Volume often provides clues about potential reversals before they happen:
- Climax volume: Extremely high volume at the end of a trend often marks exhaustion
- Declining volume: If volume decreases as the trend continues, it shows waning interest
- Volume on reversals: Genuine reversals are usually accompanied by increased volume
- Volume divergence: Price makes new highs on lower volume, suggesting weak buying interest
Moving Average Signals
Moving averages can help identify trend reversals:
- Price crossing moving averages: Price breaking below the 50 or 200 MA in an uptrend is a warning sign
- Moving average crossovers: The 50 MA crossing below the 200 MA (death cross) signals a potential longer-term reversal
- MA slope change: When a rising moving average starts to flatten or turn down, momentum is weakening
Trendline Breaks
A break of a well-established trendline is a significant reversal signal. The trend line should have multiple touches to be considered valid. A clean break with a candle close beyond the line and follow-through confirms the break.
Combining Multiple Signals
The most reliable reversal setups occur when multiple signals align. A single signal may produce false positives, but when several signals point in the same direction, the probability increases significantly.
High-Probability Reversal Setup
- Price approaches a major resistance level at the end of an uptrend
- Bearish divergence appears on RSI
- A bearish engulfing candle forms at the resistance
- Volume spikes on the down candle
- Price breaks below the rising trendline
When three or more of these signals appear together, the probability of a reversal increases substantially.
Common Reversal Trading Mistakes
- Calling reversals too early: Trying to catch the exact top or bottom often leads to losses
- Ignoring the trend: Trends tend to persist, so reversal signals need strong confirmation
- Using single signals: Relying on just one indicator without confirmation from others
- Fighting strong trends: In powerful trends, reversal signals often fail
- No stop loss: Reversals can fail, always protect your capital
- Wrong timeframe: Reversal signals on lower timeframes are less reliable than on higher timeframes
Waiting for Confirmation
Rather than trying to catch the exact turning point, many traders wait for confirmation that a reversal has occurred:
- Wait for a clear break of structure (lower low in uptrend, higher high in downtrend)
- Wait for a close below key support or above key resistance
- Enter on a retest of the broken level rather than on the initial break
- Look for lower timeframe confirmation of the higher timeframe reversal signal
Track Your Reversal Trading Results
Pro Trader Dashboard helps you analyze which reversal patterns work best in your trading. Track your win rate on different pattern types and optimize your reversal trading strategy.
Summary
Identifying trend reversals is challenging but rewarding when done correctly. The key is to use multiple confirmation signals: chart patterns like head and shoulders and double tops, divergence in momentum indicators, volume analysis, and breaks of key levels and trendlines. Never rely on a single signal, always wait for confirmation, and remember that many reversal signals fail. Proper risk management is essential when trading reversals.
Ready to learn more? Check out our guide on trend continuation patterns or learn about counter-trend trading.