The 2 Types of Trades in the Market

When you begin trading, you will realize that there are only two types of trades.

One is the reversal trade.

And the other one is the continuation trade.

A reversal trade is a trade where you are going against the trend.

So for example, if you use Bollinger Bands on your charts, you could take the slope of the middle band as an indication of the trend.

So if the middle band is sloping up, you would assume that it is an uptrend.

If the middle band is sloping down, it would be a downtrend.

And if the middle band is flat, then it's a trendless market.

Now, a reversal trade would be a trade where you are going against the trend.

So for example, if the middle band is sloping down and you are taking a long position, that would be a reversal trade.

Similarly, if the middle band is sloping up and you are taking a short position, that would be a reversal trade.

On the other hand, a continuation trade is a trade where you are going with the trend.

And trend by the way, is what you define for yourself.

Some people might trade the daily charts, but use the weekly middle band as the indication of trend.

Some people might use the middle band on the daily chart itself as an indication of the trend.

So it's really how you define trend for yourself that matters.

And consistent with that definition, you could decide what type of trade you are getting into, a reversal or a continuation.

If you are going in the direction of the trend, it's a continuation trade.

If you are going against the direction of the trend, it's a reversal trade.

For a reversal trade, you need more confirmations, since you are going against the trend.

So, for example, you might want to look at divergences from indicators such as RSI.

RSI provides bullish and bearish divergences to support your reversal trade decision.

On the other hand, continuation trades would not require as much confirmation, as a reversal trade would require, because you are going with the flow.

You are going with the market participants.

So, a continuation trade is a high probability, low risk trade.

Reversal trade is a low probability, high risk trade.

However, the reward to risk ratio on a reversal trade can be far higher than the reward to risk ratio on a continuation trade.

Because, on a reversal trade, you are trying to catch the new trend very early on the chart.

So, the next time whenever you open a chart, ask yourself, are you taking a reversal trade? Or is this a continuation trade?

If you are getting into a reversal trade, then look for as many confirmations as you can, because you are really going against the flow of the market.

Thank you so much.

Regards,

Rohit Musale, CFA

14 February 2023