J.E. Forex Reversals. Retests. Rejections.

Before reading this you should already have a good understanding of Support and Resistance and Market Structure because these are key to all plans and I will not be explaining them here, only how I interact with and interpret them for taking trades. This document goes through what my strategy is, all the different aspects of it and how to actually trade it. I trade this strategy because I find it works better than direct breakouts for my personality and trade style, but it is all based off of an understanding of Support and Resistance and Market Structure just like the breakout strategy is.

What is a Reversal?

A reversal is simply a change in direction of price movement from up to down or vice versa. They happen countless times each day and can be anywhere from a few pips in distance to 100s of pips, depending on the time frame and strength of the reversal. Mini reversals are often called pullbacks, which refers to when a price is in momentum one way, but forms a short term reversal and pulls back in the other direction for a short time. Major reversals, where the trend changes, most commonly occur at major support or resistance levels.

What is a Retest?

To understand retests you must understand support and resistance and the concept of support becoming resistance and resistance becoming support - in this document I will assume you do understand that. A retest literally means the testing of a level again, but there are different forms of retest visible on the chart.

Firstly, we can break a level of support for example, and then immediately retest it as resistance, or vice versa. See below.

We can also find retests of levels much longer after a break. Price will move quite far away from the broken level before finally coming back to retest it. See below.

Support and resistances are levels that price bounces around between as it moves. Support stops price from moving down so it usually bounces up and resistance stops price moving up, so it usually bounces down. However, when we break down from support for example, how do we know for sure that price will keep going down? This is through the retest. The retest can occur at any time, immediately after a break or hours after, and it is price validating that that level that used to stop it going down, will now stop it going up. It is like the doors opened to let you down, but now they are locked again to stop you going back up, which confirms that the only way left to go is down. This is to do with the supply and demand levels breaking; if no one will pay £1 for something anymore you have to drop the price so that people will buy it (so the £1 support has broken). You can try charging £1 for it again but still no one wants it for £1 (the retest) so you have to keep dropping the price until a lot of people want it again.

What is Rejection?

Rejection is very easy to spot on a candlestick chart and it is also very important. It is evident through the wicks of candles, which show that price attempted to push in to or past a zone or level but ultimately rejected that level and pulled back away from it.

The order of events when finding a set up

1. There is no set up if price is not at a major level. We can see all the confirmations we want but if price is not at a major level then they mean nothing. You already know what a major support or resistance level is by now, but the major levels I use for this strategy can be key zones, horizontal line levels, major trend lines, key EMAs or fibonacci retracement (especially 61.8). The zones, line levels and trend lines are always drawn on high time frame (h4 or above) unless there is an obvious important one on the h1. The EMAs can be the 14 EMA retest when price pulls back to it after a strong push away, or it can be the 200 EMA as a dynamic support or resistance that price respects when pushing towards it. Fibonacci is used to measure the pullback after impulsive moves of momentum, and we must see rejection and confirmations at the key levels between 38.2 and 61.8%. Fibonacci is drawn from the major swing high/ low to the major swing low/ high on the time frame I am looking on. 
2. If momentum is too high in the opposite direction to your desired reversal direction, then it is likely you will be faked out even if you do get confirmation price action patterns. For example, if you hit a major resistance zone and you see an m30 bearish engulfing right at the start of a new h4 candle, but the last few h4 candlesticks were hugely bullish, it is better to wait and see what will happen as high time frame momentum can take a while to wear out. Therefore, I would not enter sells here even though we have had a bearish confirmation because the last few high time frame candles had strong bullish momentum. If you would like to know more about identifying momentum I suggest you watch this video: https://www.youtube.com/watch? v=xq7Vzrbdtyc
3. Once we have identified that price is at a major level and momentum is not too high, we can look for rejections at this level - the higher the time frame you find a rejection wick on, the stronger it generally is. Here we look for rejection wicks on m15, m30 and h1. Sometimes you can see nice rejection wicks of zones on the h4 and Daily charts but i rarely enter on these as they do not give good risk reward ratios for trades. As you can see from the rejection chart above, these wicks are very easy to spot and indicate that a reversal could be coming soon.
4. To confirm that this reversal or pullback is indeed going to happen, we look for confirmation price action patterns on multiple time frames - again especially m15, m30 and h1. The more confirmations we see on the more time frames, the higher probability the set up is. If you see that price has reached a major resistance zone, momentum is wearing out on high time frames like h4, we have printed wicks in to that zone and finally we have bearish confirmation patterns on m15, m30 and h1, then you have found yourself an incredibly high probability trade. However, it is incredibly important that the price action confirmation patterns are the last thing you look for in these trades, without the first three steps they are useless and will lose you money if you follow them alone.

Price action confirmation patterns

I am not going to explain the psychology behind each of these price action patterns as there is already explanation available online and in the drive, but these confirmations signal that bullish pressure has changed to bearish pressure and vice versa. I look out for these confirmations in particular as the final step in confirming a potential set up is good to enter. The best high- probability set ups are found when you see one of these confirmation patterns on multiple time frames at the same time (as I will demonstrate later). Remember, the first 3 steps must be completed first; these patterns are used as entry points and to confirm what you should already be thinking.

Chart Patterns

Chart patterns are very useful to this strategy because, if you know textbook price movement in these patterns, you can have a good idea of likely reversal points. The following are the main patterns I use and again I draw them on the h1 and higher. Sometimes you can see a good looking pattern on lower time frames but they are less reliable.

Standard reversal at a major zone

A standard reversal at a major zone is where price approaches a level of major resistance, for example, that we already know is resistance, and reverses at it. Obviously these also occur at support. We use multiple time frames to confirm these reversals as that is how we get the highest accuracy - you need patience to wait for these set ups but they very often have brilliant risk reward ratios, so the wait is very very worth it. Below is an example where I explain everything I would look for in one of these reversals, my thought process regarding momentum and where I place my stops and take profit targets.

Because we have higher time frame confirmations at major level reversals like these, that is why we are able to have larger targets. If high time frame momentum is changing, it is likely this new momentum will last for longer, thus we can have bigger targets for better risk reward.

Also, note this exact strategy and thought process is also applicable to major trend lines and other major levels. This is why I have explained it first, because it is the basis of all the different types of reversal set ups I take.

Retest of a broken zone

For these, I will use the examples from the ‘What is a retest section?’. Like all of the other entries i take I still follow the 4 steps laid out earlier when looking for the retest trade and the confirmation candle patterns are very important. The process for taking retest trades is very similar to the standard reversals, except immediate retests usually require momentum to be high, as immediate retests come straight after a break of a zone. Also, for immediate retests we find confirmations on lower time frame and use the high time frames to ensure momentum is in your favour.

The longer retest is very similar to a standard reversal, so the way we trade it is exactly the same.

The key to remember is that when taking an immediate retest, you want momentum to be strong to continue the breakout after the successful retest in which you enter. In contrast, with long term proper retests, you want momentum to be slowing and changing direction in the same way you would for a standard reversal.

Scalp reversals

For this example I will use trend lines as the major level, to show how you can use these as well as major zones and lines - again, the process is the same for this type of entry on each. With scalp reversals, we look for initial signs of high time frame rejection and then enter on the low time frames to try and catch a small pullback/ reversal rather than a big move. This is a slightly more advanced strategy as it requires high concentration levels and a strong awareness of market sentiment, momentum and price behaviour at major levels. This is the set up that I take least often of all in my plan, but if you can identify the strongest exact levels, like the following trend line intersection, it is possible to take these quick scalp pips on the short, sharp pullbacks. The example below is a particularly tricky one because despite high time frame rejection we are still pushing, but I have shown you how to trade the hardest version of this entry so that the when you find other versions, they should be easier. TIP: look out for intersecting trend lines, they provide great points for high accuracy scalp reversals where you can be confident of pullbacks, which means you can get nice and close low time frame entries.

The m15 14 EMA retest entry

The m15 14 EMA retest is a hugely effective way of taking entries on the pullbacks from impulsive moves. The m15 14 EMA is regularly retested and rejected during a market that is in strong momentum and these retests provide good entry points to take some pips from the momentum. These trades give good risk reward because the stops are usually small (they are placed above/ below m15 market structure). It is very important to check that high time frame momentum is in your favour with these trades because if it is not, this particular EMA is unlikely to hold, so always check. In the below example, we had a major resistance zone, and had h1 bearish engulfing candles - momentum was down so after the first impulsive push, I was able to take a perfect entry on the retest and rejection of the m15 14 EMA. The risk reward was 1.5:1.

Fibonacci retracement entries

Fibonacci is a great tool for measuring the retracement of market swings and finding entry levels that are not always major zones. The key range in fibonacci is between the 38.2 and 61.8% retracement levels, with the 61.8% level being particularly effective for finding entry points. As always with trades in this strategy, we need to find rejections and confirmation candle patterns when we take reversals at these levels, just in this case the major level is the fib level, rather than always being a zone.

The following example shows the retracement of USDCHF to the 61.8 fib level (that is also the daily 14 EMA) of a major swing that you can see clearly on the h4 time frame. The swing goes from the top of the range all the way to the low of the break, before price strongly pushes back up. With fibonacci retracements, you will often find that when a strong fib level is at the same level as another strong level, for example EMAs or a major zone, then this increases the probability of the set up being good.

Understanding market structure

Reading market structure as a whole and the different structures that appear within it is key to understanding the flow of the market and being able to tell where and why reversals take place. I am not going to go in to huge depth on this as this document is more on how to trade this strategy, but this is an insight in to how I understand market structure.

The major levels are key when establishing market structure, I have drawn 3 major ones on that chart (the horizontal black lines). One obvious way to see that the overall market structure is bearish is that price keeps pushing down through and then successfully retesting them.

As you can see, it is possible to have multiple structures within the overall market structure and you can trade these structures as their own entities. Just because the overall market structure dating back a month and half is bearish it does not mean you can only take sells - as you can see price does go up during this overall trend.

Risk Reward

For me to take a trade set up there must be a risk to reward ratio of at least 1:1, meaning that for every pip I risk I must be able to gain at least one (for example if my stop loss is 10 pips, my take profit would have to be a minimum of 10 pips away). I do this as not only does it maximise profits and ease pressure to have a high win rate (with a 1:1 risk reward you only need to win 50% of trades to break even), but for the principle that I am not willing to risk more than I could possibly gain. Why would i do that? I wouldn't take a bet with a friend where if he wins I give him £100 but if I win I only get £50, and it is the same with trading. Having a risk reward that always skews in your favour is a very useful tool to put yourself in the best possible position to succeed in trading. Also, you will find that with this strategy the risk reward is usually far greater than 1:1. 1:1 is simply my minimum. I risk 2-3% per trade.