Trend reversals

trend reversals
All of us are trading to make money. The greatest fear that a beginner has is losing money. Many erroneously try to prevent this by using the smallest stop possible, not aware that there are two other variables that are just as important. This makes him always want to buy the exact bottom or sell the exact top because he realizes that the stop is then close to his entry, just beyond the opposite side of the signal bar. He sees lots of great trend reversals in books and on websites and assumes that they are common.

However, he wonders why he watches the market day after day and never sees anything as perfect as what he was hoping to find. The reality is that there has to be an institution taking the opposite side of his trade, and no institution is going to give him perfection because then the institution would be taking something perfectly bad…a low probability of winning where the risk is much bigger than the reward. That means that there has to be something wrong with every reversal (and with every trade!).

Island tops and bottoms usually do not lead to trend reversals in the Emini

When there is a gap up and then a gap down, or a gap down and then a gap up, an island is created. If an island forms in a trading range, the breakout usually fails because most breakouts from trading ranges fail. When one forms in a trend, the reversal usually fails because most trend reversals fail.

However, islands sometimes lead to big trends. Traders betting on the trend have a low probability trade with low risk and big reward. Other institutions take the other side, where they have a high probability of a profit, but a worse risk/reward profile. Both are acceptable. Other prefer to wait to see a strong breakout before entering because the probability is then higher.

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