The failed trend reversal is a situation where the trend reverses, but then it is unable to make progress in the new direction. The price retreats back to near the original turning point, putting the reversal in jeopardy of being reversed again.

Such situations often result in a sharp price move because a large group of traders, no matter which way the price goes, are going to be trapped and have to exit quickly.

To Understand Failed Trend Reversals, Understand Trends

An uptrend is characterized by larger moves to the upside (trending waves) relative to moves to the downside (corrective waves). This creates higher swing highs and higher swing lows.

A downtrend occurs when the price is making lower swing lows and lower swing highs.

A trend reversal occurs when an uptrend makes a lower swing low, or a downtrend makes a higher swing high.

On the chart below, there is an uptrend. Then there is a reversal, as a lower swing low developed, followed by a lower swing high. But after the formation, the price moved down only marginally and then began to rise again. 

Where is the trade? It is a long at 02:13.

In this instance, there were a few things to note from a price action perspective.

• The initial drop which indicated a possible reversal (new swing low) made very little progress relative to the prior swing low. In other words, the price just barely dropped below the prior swing low before bouncing. I refer to this as a marginal trend reversal—it was not a strong signal that a downtrend was about to start.
  
  
• Next, the price moved up and formed a lower high, consolidated, and then broke that consolidation to the downside. I would be willing to take that short trade, but I would also note that the downtrend signal was weak. If the next decline falters, I will want to get out. Stop loss goes right above the consolidation.
  
  
• The price does drop, but once again barely drops below the prior swing low. The price is not able to make much downward progress. 
  
  
• We now have two warning signs that this down move doesn’t have legs at this point.
  
  
• The price rallies back up, erasing the prior move down. This is another warning for the bears/short trades. The buyers are getting stronger; they were able to push the price almost all the way back up, erasing the prior decline. The price consolidates. 
  
  
• While that consolidation is developing it is important to consider the information we have.
  • We did have a marginal reversal to the downside, indicating a downtrend.
  • The price has not made much progress to the downside. 
  • The price has rallied back to a prior swing high and is consolidating there. 
  • An upside breakout of the consolidation signals the uptrend is likely resuming. 
  • A downside breakout of the consolidation signals the price may try to make another move lower.
  • A breakout of the consolidation in either direction is tradable.
    • An upside breakout will likely trigger multiple stop loss orders on the way up, helping to fuel the price higher. Those who sold on these little waves will have put stop losses above recent highs, likely. Those stop losses are buy orders. If they get triggered, they will help push the price up.
    • If a downside breakout occurs, keep it on a tight leash as downside movements have not shown much strength.

Here’s a video discussing the situation above.

One note on the video (which is from a couple years ago). I used to wait for consolidations a lot more, and then take trades when the price broke out of the consolidation. Consolidations are great, and it may be worth waiting for them, but I now tend to have earlier entries as the price moves above/below the prior candle, instead of waiting for the whole consolidation to break. That said, if I want a bit more confirmation on a trade, I may wait for a consolidation and breakout.

There is another example on the chart (actually a couple) just after 01:00. Here is the chart again.

The price drops below the prior swing low near 1.08740. There is a small rally the price drops again. But can’t make progress. It then starts pushing higher and consolidates. In this case, the last down move was so small I wouldn’t consider going short, but I would consider if the consolidation just prior to 01:15 breaks to the upside. And it does, at 01:15. A nice potential long trade as the move down all the bears were expecting didn’t happen. Notice this also a double pump pattern signaling a trade to the downside, but it doesn’t trigger a trade to the downside and instead goes the other way. Something to watch for.

I have used forex examples in this article…but does it happen in other markets, like stocks? You bet.

Learn to day trade stocks with strategies you can implement in the first 30 minutes of the trading day (trade longer if you wish). Capture multi-percent returns in minutes with stocks that are on the move (list provided). See the Price Action Stock Day Trading Course.

The Difference Between a Failed Reversal and a Rounded Top and Bottom

Rounded tops and bottoms are a key pattern covered in my EURUSD Day Trading Course.

The main difference between a RT/RB and a Failed Reversal is the Failed Reversal has an early entry.

Look the 02:13 entry above. It occurs below the prior swing high at 02:05. We actually don’t have a shift up yet. This is still a short-term downtrend, just a weak one.

The failed reversal is also different than a Failed Tech Turn. A failed tech turn has an even early entry than the Failed Reversal. The failed tech turn gets in as soon as the fails to make progress. A Failed Reversal waits till the price almost reverses back the other way, and then enters if it continues in that direction (if it goes the other way, it is just a trend trade, but in a weak trend, and I generally avoid such trades unless there is enough movement for my target to be easily hit).

Failed Trend Reversals and Price Action Trading

Price action trading is a constant task. Price waves are always unfolding. The price action trader needs to be on top of them, analyzing them. 

The price action trader is always thinking ahead and assessing what they will do if the price drops, rallies, makes a lower higher, a higher swing high, a higher swing low, etc. I discuss this stuff with myself. A process I call “commentating.” It greatly helps to strategize and be ready for trades…which can develop quickly.

Not every false trend reversal will look like this. In this case, the price gave us a nice opportunity to get in. Sometimes the price will reverse too quickly, in which case, we wait for the next valid trade opportunity we see.

Any time a pattern fails, or a trend reversal fails, or even when the price is nearing a major support or resistance level, a large group of traders are going to be in trouble. That often means a quick and profitable price move if you can see it unfolding and act on it. See Why Prices Move Like They Do for more on this.

How I Trade Failed Trend Reversals

I don’t trade these patterns all the time. But occasionally you will see an entry on my charts where I enter a little bit earlier than a typical rounded bottom/top or another pattern would indicate. Or the price hasn’t fully reversed (the initial reversal) so it looks like I am trading against the trend. Like the examples above; the price hasn’t shifted up again, it is just very close, so we wouldn’t typically consider a long, but given the shorts are trapped IF the price breaks the consolidation higher, the long is an option.

The reason for that early entry is often this failed reversal scenario. Traders are about to get trapped IF the price breaks a consolidation in a specific direction. So either direction, it may be a good trade.

Other trading guidelines still apply, such as avoiding drift and whipsaw candles, and monitoring for “range rules” and adequate movement.

Below is one I opted not to take…a long at 6:18. Note there is a possible reversal to the downside at 6:10. But it is very weak, barely able to make progress below the 6:02 low. We then get a rally up (doesn’t make a new high). The price tries to drop again. This time it is very weak, not even able to make it to the prior 6:10 low. The price then pushes up again. 6:18 is an attractive entry. And actually would have worked out well. But at the same time. The movements were so small over the last 15 minutes it was hard to justify taking a trade in what could also be considered choppy price action. The price continued to be choppy after that as well, so both assessments were correct…the price proceeded higher but with small choppy moves.

If you really like this pattern, and it makes sense to you, consider adding it to your arsenal. If you don’t really see it, are unsure about it, or don’t quite understand how it works, don’t use it or even think about it. Keep trading the strategies you are trading. Possibly down the road, it is something you can start to incorporate if you start to see organically see it while trading your other strategies.

This strategy composes VERY LITTLE of my overall profit each month. The main money comes from RTs, RBs, TCs, and some DPs and Snap Backs. Really, the only reason I am sharing this strategy is that understanding the psychology behind it is important for understanding why prices move like they do.

If see a reversal, and then it fails and you get that big run in the opposite direction…that is likely this pattern playing out.

The quickest path to profits is mastering one strategy at a time. Only once you have mastered one thing should you move on to incorporating another.

This is an element you can add to the strategies covered in the EURUSD Day Trading Course – strategies designed to capture big profits in 1-2 hours of trading per day (trade longer if you wish).

Cory Mitchell, CMT

Disclaimer: Nothing in this article is personal investment advice, or advice to buy or sell anything. Trading is risky and can result in substantial losses, even more than deposited if using leverage.