Trends or Reversals: Which Is Better?
Updated: Nov 3
Trend vs Reversal Trading offers a useful case study in turning market observations into repeatable trading rules. This updated guide preserves the original Financial Wisdom analysis while separating practical lessons from exceptional results and hindsight.
Trends Or Reversals: In This Guide
Key lessons and practical rules
The original Financial Wisdom guide and media
Evidence, limitations and risk controls
Frequently asked questions
Related guides and authoritative sources
Key Takeaways
Translate the central idea into objective entry and exit rules.
Test the method across different market regimes and include costs.
Use price, volume and market context without treating any signal as certain.
Define invalidation and position size before entering.
Original Financial Wisdom Guide
Background and Core Ideas
How to decide which is the best Stock Trading Strategy for you.
Most positional traders and swing traders either specialize in trading trends or reversals. The most consistent and successful ones trade trends, although some legendary traders like George Soros and investors like Warren Buffet have also made a lot of their fortune looking for reversals.
My personal preference is 'trends' for singular stocks and 'reversals' for indexes and ETF's.
When Warren Buffet started investing as a business, he was a staunch Benjamin Graham follower. Warren would actively scout for opportunities that were mispriced, load on to them, and wait for them to reverse and deliver a handsome profit. It worked quite well for him given he became a multi-millionaire following that strategy.
Even now, he says he could deliver over a 50% per year compounded return, investing using the same strategy, if he had less capital to invest.
On the other hand, some investors and traders only invest in or trade trends and have built a fortune out of the same. Traders like Jim Rogers, Paul Tudor Jones, William O’ Niel, and Mark Minervini have had many years of consistent and successful track record of generating handsome returns with trend trading.
The Basics
So, what is the difference between these two forms of trading, and which one should you choose?
Trend trading is when you bet on the continuation of a move.
Practical Checkpoint
Define the setup, entry and invalidation level before acting.
Compare the potential payoff with risk-reward planning.
Set the trade size using consistent position-sizing rules.
Rules and Practical Application
Traders mostly look for trends that are expected to last for varying lengths of time ranging from a week to a few years. The idea here is to look for continuation moves when the price is in a medium or long-term trend.
While trading trends, traders would have different systems to initiate the trades. These systems are designed to give entry signals either in pullbacks from the primary trend or towards a breakout when the continuation of the trend looks more probable.
My preference is a lateral consolidation on a weekly chart, this lateral movement provides rationale for a low risk stop loss. As such I developed a bespoke scanner just for my approach. https://youtu.be/fCH1_3Ikv4I
As a reversal trader, you would be on the lookout for oversold or overbought opportunities. Reversals are quite rewarding if you can maintain a decent win ratio and a favourable reward-risk.
However, reversal trading requires much more skillful execution than trend trading because markets trend most of the time, and reversal opportunities are far and few. But, one can build a fortune trading reversals only by getting a few trades right, whilst riding the winners while cutting the losers short when they are small.
The reversal approach is not something I would advise for singular stocks, its is often like catching a falling knife. Diversified funds yes, single stocks no.
Pros and Cons
There can be several ways to make money in trading and there is no one size fits all. Each form of trading has different benefits that suit the psychology of different kinds of traders. When it comes to choosing between the trend and reversal trading, it’s always “to each its own”.
Trend trading is relatively easy as markets trend most of the time and you will have ample opportunities to trade in all kinds of markets. Though rewarding if practiced rightly, it can also be an easy money guzzler if you don’t play by the rules and do not regard risk management.
Evidence Check
Is the sample broad enough to include difficult markets?
Do the results include spreads, fees, slippage and failed signals?
Could hindsight, survivorship or selective examples explain the result?
Evidence and Examples
Reversal trading, on the other hand, requires a lot of patience with very skillful execution for two reasons:
1) The opportunities are less than that in trend trading, and
2) The chances of errors are higher than that in trend trading, making risk management even more important.
Trends are easier to spot and trade than reversals and many traders are doing it successfully for years. The markets also haven’t changed much when it comes to trends, unlike reversal trading or value investing as it was called in earlier days, where opportunities are diminishing decade after decade.
Where do trend and reversal trading fit in human psychology?
When it comes to buying financial assets, the human mind is always programmed to buy low and sell high or vice versa. That’s not bad but it’s not as easy as it sounds and is also not always rewarding. While buying the dip may help newbies in strongly trending markets, there are often dips that don’t recover quickly. Some of them don’t come back at all (The singular stock issue).
At these points, uniformed and naïve traders keep buying lower and ultimately block their capital in duds (Opportunity cost). The markets then recover and move up without their stocks, as leaders of one bull market rarely lead the next.
Buying the dip profitably needs much more depth in analysis. It’s not as simple as buying a high-flying stock as soon as it cracks. That’s where the dumb money buys and smart money dumps. It’s certainly not a happy place to be.
Therefore, trading reversals has to be done with a clear strategy and robust risk management. One should not buy falling knives or short overshooting prices thinking that the price will reverse right when you put in the trade.
Risk and Limitations
The concept of buying high and selling higher or selling low and buying even lower is alien to many but has been used successfully and consistently by many great investors. This approach provides better entry points and equally clear stop-loss points that removes a lot of subjectivity from trading. This counterintuitive approach to investing or trading also eliminates a lot of competition and makes you move in the direction of smart money.
The final word
There is a long learning curve in getting proficient in any form of trading, which is equally true for both trend and reversal trading. Whichever form you choose to trade, you will have to practice it for years together to be great at it. But once you have been through the grind, the money-making from trading almost goes on autopilot mode.
There will be many mistakes along the way, but the key is to not make irrecoverable mistakes, be open-minded and keep on working to be better at whatever form of trading you choose.
Learn rigorously about the two style of trading/investing and choose whichever style suits your trading objective, psychological makeup, and temperament.
My breakout strategy - 15 page rule book (PDF) is available for all members to use.
My Breakout Scanner - https://bit.ly/3ea6sl8
My Forum - https://www.financialwisdomTV.com/forum
My Strategy Blueprint - https://www.financialwisdomtv.com/plans-pricing
Summary of the Original Guide
My Brokerage Account (Interactive Brokers) - https://bit.ly/3HVA1nc
Practical Limitations
Historical examples, book claims and indicator results are educational illustrations rather than forecasts. Outcomes depend on the market, timeframe, data, transaction costs, financing, taxes and execution assumptions. Test complete rules across varied conditions and define the maximum acceptable account risk before taking a position.
Put This Into Practice
These ideas become more useful when selection, entry, stop placement, position sizing and trade management form one repeatable process. The Financial Wisdom Trading Blueprint connects those decisions in a practical weekly framework.
Frequently Asked Questions
Does this strategy guarantee profitable trades?
No. It provides a framework with uncertain outcomes and must be tested with complete risk and execution rules.
What should be defined before an entry?
Specify the setup, trigger, invalidation level, position size and conditions for managing or exiting the trade.
Further Reading
References and Further Reading
Educational information only. Trading and investing involve risk, including the possible loss of capital. Examples are illustrative, not guarantees of future performance, and nothing in this article is personalised financial advice.
About the Author
Written by Gareth, MBA
Gareth, founder of Financial Wisdom, has more than 30 years of personal trading experience. He competes in the United States Investing Championship, creates award-winning trading content and has been featured in Technical Analysis of Stocks & Commodities.
The winning rate, odds and trading frequency of the trading system determine the profit of the system, and the system must be in line with one's own personality in order to be implemented. It takes time to find a system that suits one's own personality. During this time, trial and error is required, and it cannot go bankrupt. . The author is really good at writing, and the transaction should be good too!
Based on my own somewhat limited reading, the trick is to not lose more cash than you make! No matter what technique/system, it seems a well worked out stop loss will help ensure a higher probability of profits. Cheers