Reversal

What Is a Reversal?

A reversal is a change in the direction of a security's price trend. An uptrend that stops rising and begins falling is a bearish reversal, sometimes called a top reversal. A downtrend that stops falling and begins rising is a bullish reversal, or bottom reversal. Reversals are studied in technical analysis, where analysts look for signs that the prevailing momentum is losing strength.

How Reversals Are Identified

Analysts rarely identify a reversal from a single price move. Instead, they look for patterns on a price chart that suggest buying or selling pressure is shifting. Commonly cited reversal patterns include:

• Head and shoulders, which often forms near a top
• Double tops and double bottoms
• Rounding bottoms
• Divergence between price and a momentum indicator, such as the relative strength index

Volume is often examined as well. A reversal accompanied by heavy trading volume is generally viewed as more meaningful than one on light volume. Many analysts also wait for confirmation, such as a close beyond a key support or resistance level, before treating a move as a true reversal rather than a brief pullback.

Limitations

Reversals are difficult to recognize in real time. A price move that looks like the start of a reversal may only be a temporary correction within a larger trend, which is often called a false signal. For this reason, reversal signals are usually weighed alongside other evidence and are not treated as certain predictions. Technical analysis in general is debated among researchers and investors.

Reversals in Accounting

The word also appears in accounting, where a reversing entry is a journal entry made at the start of a period that cancels an accrual recorded at the end of the prior period. This is a separate meaning and should not be confused with a price reversal.