Reversal Bar Indicator

Reversal Bar Indicator

A reversal bar is a single bar or candlestick on a price chart that signals a potential change in the direction of the market trend. The reversal bar indicator scans price action to identify reversal bars and alerts traders to these high probability turning points in the market.

Reversal bars are important because they mark exact levels where buyers take control from sellers, or vice versa. Plotting these pivotal points as an indicator on a price chart provides traders with a visual tool to improve the timing of entries and exits. The indicator also helps confirm trend reversals.

This article will explore the key concepts behind the reversal bar indicator, including:

  • What reversal bars are and why they are significant
  • How the reversal bar indicator works
  • Interpreting common reversal bar patterns
  • Using the indicator to define support and resistance
  • Incorporating reversal bars into a trading strategy
  • Tips and precautions for trading with the indicator
  • Example setups and trading scenarios

Understanding price action is a fundamental skill of professional traders. The reversal bar indicator is a valuable addon tool for spotting high probability turning points derived directly from the price bars on the chart.

Reversal Bar Indicator

What is a Reversal Bar?

A reversal bar refers to a single bar or candlestick on the price chart that signals a potential reversal in the direction of the trend. It represents a level where bulls (buying pressure) take control from bears (selling pressure), or vice versa. This transition is reflected in the open, high, low and close values of the bar.

There are a few characteristics that define a bar as a reversal bar:

  • The open and close are at opposite ends of the bar, creating a large body. This shows a transition from bullish to bearish sentiment or vice versa within that bar’s timeframe.
  • The close is near the high/low of the bar. This indicates buyers/sellers took control and pushed the price to the extreme range of that period.
  • There is little or no overlap with the previous bar. Overlap shows indecision so low overlap strengthens the signal.
  • Large bar range and above average volume (where available) support the conviction behind the reversal.

When these qualities come together, the bar signals a high probability reversal point in the market. Isolating and plotting these bars on the chart makes them readily visible to traders.

Why Reversal Bars Are Important

There are a few key reasons experienced traders pay close attention to reversal bars:

  • They clearly signify transition points between buyers and sellers. Knowing who is in control gives an edge.
  • They condense the complex dynamics of markets into simple visual patterns. This makes analysis easier.
  • They isolate exact levels/prices where reversals occurred previously. This creates logical support and resistance levels.
  • They provide high probability reversal trade setups with predefined risk and profit targets.
  • They help confirm whether a reversal is genuine as part of a broader analysis.

In essence, reversal bars cut through the noise of the markets to pinpoint areas of order where the smart money is entering or exiting positions. Plotting them makes these trading clues visually obvious.

How the Reversal Bar Indicator Works

The reversal bar indicator scans the price history to identify past bars that possess the key attributes of a valid reversal bar. Each bar that fulfills the criteria is marked on the chart so traders can clearly see the exact reversal levels.

Indicator Logic

The indicator runs through the following logic to determine if a bar qualifies as a reversal bar:

  • The open and close are at opposite ends of the bar’s range
  • The bar has a large body to range ratio (typically over 60%)
  • The bar close is near the high or low of the bar range
  • The bar has relatively low overlap with the prior bar (configurable setting)
  • The bar meets minimum range and volume requirements (user configurable)

Any bars fulfilling these rules are plotted on the chart. The trader can then reference these levels for trades and support/resistance.

Key Parameters

The indicator has a few customizable parameters:

Body to Range %: The minimum body size as a percentage of the total bar range to qualify as a reversal bar. Larger bodies signal stronger conviction.

Overlap Limit: The maximum permitted overlap/gap between the reversal bar and prior bar. Lower overlap supports validity of the reversal signal.

Minimum Bar Range: The minimum price range required for a bar to qualify as a reversal bar. Filters out small bars and noise.

Volume Filter: Option to only mark bars with above average volume (where volume data exists) as reversal bars to confirm strength.

Left/Right Bars: Number of bars to the left and right of potential reversal bars to include in overlap and volume filters.

Optimizing Parameters

The indicator parameters can be adjusted to fine tune the reversal bars identified for a particular instrument and time frame. For instance, shorter time frames may require tighter range and overlap limits to reduce false signals.

The most significant parameters are the body to range ratio and permitted overlap. Traders will generally experiment with these two settings to find the optimal values for a given market.

Interpreting Common Reversal Bar Patterns

Reversal Bar Indicator

There are a few classical bar and candlestick patterns that produce clear reversal signals when they fulfill the reversal bar criteria:

Pin Bar

The pin bar has a large body with a small wick (tail) protruding in the opposite direction. It shows a sharp price rejection and reversal off a level. Pin bars are particularly significant when they form at swing points or Fibonacci levels.

Engulfing Bar

An engulfing pattern occurs when the body of the current bar fully encompasses or “engulfs” the body of the prior bar, signaling strong rejection. The larger the engulfing bar, the more significant the reversal signal.

Outside Bar

An outside bar forms when the current bar’s high and low exceeds the range of the prior bar, engulfing the previous bar’s range completely. It shows intense buying or selling pressure in the new direction.

Two Bar Reversal

This reversal pattern unfolds over two bars. The first bar continues the current trend, but the second bar breaks the low/high of the first bar and closes in the opposite direction, constituting the reversal bar.

Key Reversal Day

In this long tailed bar, the price pushes to a new extreme in the trend direction but reverses aggressively to close at/near the opposite end of the range. This signals trend exhaustion.

There are many other candlestick patterns like doji’s, shooting stars and hammer bars that produce reversal signals when they meet the reversal bar criteria. Plotting them makes identification easy.

Using the Reversal Bar Indicator to Define Support and Resistance Levels

One of the key uses of the reversal bar indicator is identifying levels of support and resistance derived directly from price action.

Past reversal bars show levels where buying or selling previously came in strongly and reversed the market. These areas are likely to see battles between buyers and sellers again when retested.

Some applications of the indicator for defining support/resistance include:

  • Long wicks on reversal bars create support/resistance at the wick lows/highs
  • Clusters of reversal bars together form significant support/resistance zones
  • Bars closing near the range high/low indicate strong reversals to monitor on retests
  • Strong reversal bars near swing points or Fibonacci levels are particularly noteworthy
  • Bars forming after a substantial trend highlight important pullback/retracement levels

The indicator visually highlights all these key levels on the charts for easy reference. Traders can reinforce analysis by combining reversal bars with classical support/resistance analysis.

Incorporating Reversal Bars into a Trading Strategy

Traders can incorporate reversal bars into their trading plan in a few ways:

Entry Trigger

Reversal bars can trigger entry directly – long on bullish reversal bars, short on bearish bars. Stop loss placed beyond bar high/low, target previous swing point.

Exit Signal

When price approaches an existing reversal bar in opposite direction, traders can exit positions and lock in profits before new reversal potentially occurs.

Combination Strategy

Confirming reversal bars with other indicators like MACD crossing, Stochastics oversold, or RSI divergence creates robust combination strategies with clear rules for entry, exit and risk management.

Breakout Trading

Monitoring price behavior as it returns to reversal bar levels offers breakout trade opportunities if support or resistance breaks decisively.

Warning Sign

If a current trade moves back to a prior reversal bar, it serves as a warning that conditions may be shifting, allowing early defensive action.

No single indicator provides an all-encompassing trading system. But incorporating reversal bars and the indicator into a broader strategy can certainly enhance outcomes for traders.

Tips and Precautions When Using the Reversal Bar Indicator

While the reversal bar indicator offers useful trade signals, traders should employ some tips and exercise precautions to avoid common pitfalls:

  • Not all reversal bars produce successful reversals – apply filters to qualify the likelihood
  • Combine with other indicators/analysis for confirmation of genuine reversals
  • Monitor reversal bar strength – weak bars are less significant than strong bars
  • Give reversal trades room to work to avoid premature stop outs
  • Beware fakeouts – especially around news events or low liquidity periods
  • Consider momentum – strong momentum may override reversal signals
  • Plan appropriate risk/reward ratios for trades based on reversal bars

The indicator find high probability setups, but broader context is required to time entries and exits optimally. Using prudent analysis alongside the indicator provides the best results.

Conclusion

The reversal bar indicator is a valuable contribution to any active trader’s toolbox. Identifying past price action patterns that signaled real reversals provides an edge in pinpointing high probability turning points.

However, reversal bars are just one piece of the puzzle. Employing solid analysis to time entries and exits in alignment with the broader context and market conditions is key to maximizing success. Used prudently, the reversal bar indicator delivers a unique perspective to spot trait-able market swings based purely on the story told by past price action.

Key Takeaways

  • Reversal bars are single bars/candles that signal potential trend reversals
  • The indicator scans price action and marks bars meeting reversal criteria
  • Patterns like pin bars, engulfing bars and 2 bar reversals produce clear signals
  • Levels and zones around reversal bars provide support/resistance
  • Combine indicator with analysis of momentum, other indicators for best results
  • Use reversal signals to time entries and exits, define risk, spot breakouts

FAQs

What is the best setting for body to range ratio in the reversal bar indicator?

For day trading the 60-65% body to range ratio works well. For swing trading 70-75% is ideal to filter out weaker reversal bars. Traders should backtest to find the optimal setting.

What is more important, body to range ratio or lack of overlap in reversal bars?

Minimal overlap is the most critical factor in qualifying strong reversal bars. The large body shows conviction, but low overlap confirms buyers/sellers absorbing all orders driving the price in the previous direction.

Can you use reversal bars as a stand alone strategy?

It is generally advisable to employ reversal bars as part of a broader strategy using other indicators or analysis for context. Relying solely on the indicator may lead to mediocre results or excessive whipsaws in choppy markets.

How do you avoid false signals with the reversal bar indicator?

No indicator is perfect. But requiring strong body to range ratios, low overlap and volume confirmation creates strict qualifying rules to weed out weaker reversal bars prone to false breaks.

Should every reversal bar marked be considered a trade?

No, not necessarily. Reversal bars are levels/zones to watch for bounces or breaks to enter at opportune points. Monitoring price behavior around the bars is key, rather than immediately trading each signal mechanically.

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