There are several important factors that will determine your success in trading stocks. One obvious factor is effective stock picking and identifying the stocks that you are going to buy or sell. However, knowing when to buy or sell is as important as knowing what to buy or sell. This is where trading signals come into prominence and your ability to generate and analyze these signals will help you to be a more successful trader. One major aspect of using signals is knowing how to use signals that indicate trend reversals.
Trend reversals can be very powerful signals and offer profitable trading opportunities if you spot them early. They offer a large upside with a limited downside and you can operate with tight stop loss prices. This means that if your reading of the signal turns out to be right, you are looking at large profits. If you read the signal wrong [which happens to the best traders occasionally as well], you should be able to close out your position with only a modest loss. You should hone your abilities to lead market sentiment and the trend reversals that follow the changes in these sentiments. You should also remember that different trend reversals vary in strength and you should be careful in your choice of which trend to act upon. This way, you can maximize the opportunities for high probability trades.
Broadly speaking, when you see a signal that indicates a trend reversal in a trend that has been in place for a long time, you are probably looking at a major reversal in the primary trend of the stock or the market. If the overall market trend is also in the direction of your signal, it should be considered a strong signal. If, however, indicates a reversal after a short period of time [3 weeks or less] or if some of the important conditions are not fully achieved, it should be regarded as a weak signal.
Reversals can take place during the trading day if there is a sudden surge of buying or selling and these are known as intraday trend reversals. They can also take place outside trading hours when the market is closed because of some significant news or development and these are referred to as inter-day trend reversals. Intraday trend reversals can happen because of different reasons. They can happen because of important economic or political developments that have an impact on the stock market as a whole. This causes active traders to revise their views and hence change market sentiment. They can also happen because large and influential traders start to buy or sell stocks in large quantities to benefit from what they perceive as overvaluation or undervaluation. These are abrupt changes that can cause unwary investors to be taken by surprise.
Inter-day trend reversals happen for the same reasons except that the news is disseminated outside trading hours when the market is closed. This is often company specific information or news because many countries including the United States prohibit companies from releasing sensitive information affecting stock prices during trading hours. This necessarily means that the information becomes available only before or after trading hours. At the opening of the markets, there can be a sharp decline or rise in the stock price.