All trends operate in the form of waves, consisting of main upward waves and corrective waves. Entering the market during a corrective wave is a very common trading pattern, and when entering on a corrective wave, the opening price is better, the stop-loss space is smaller, and the profit space is larger.

However, there is a main issue with entering on a corrective wave: we originally thought the market was correcting, and we entered the order, but the market reversed, causing the order entered on the corrective wave to be stopped out, catching us off guard.

So, how can we determine whether a market trend is correcting or has already reversed? How should we trade the corrective wave most appropriately? Today, let's discuss this topic in detail.

1. Can we accurately determine whether the market is correcting or reversing?

Many friends often send me a screenshot of the market trend, asking whether it will correct or reverse next. My answer is "I don't know."

There may be a misconception in everyone's trading cognition, thinking that there are certain secrets that can accurately predict the future market trend.

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My early thoughts were the same as everyone else's. I tested N different indicators and methods, and also tried to find this magical secret, but all failed without exception, and I kept struggling in the quagmire of losses.

It was only after I started making profits that I truly understood that the future is unknowable, and no one can accurately predict it.

You can imagine that if a certain pattern will definitely reverse in the future market, then this rule will be mastered by many people. Once more and more people form a consensus, this pattern will become ineffective.

So instead of focusing on useless market predictions, it's better to think of ways to capture the patterns we want to trade.Next, I will discuss two technical methods for defining callbacks and reversal standards, along with examples, and at the end of the article, I will also explain some common questions that people often have.

2. If we cannot predict the market trend, how should we trade?

We can define our own standards for callbacks and reversals.

In the financial market, all standards for trends are artificially defined. For example, Dow Theory defines the basic concept of trends, and the standards for the golden and death crosses of moving averages. "The Clarity of Trading" also mentions the trading perspective of "legislating for nature by humans."

Each of us traders can also define our own standards for callbacks and reversals, and form a trading system under these standards.

I will talk about two of the most commonly used methods for defining callbacks and reversals:

1. External Reversal.

External reversal refers to the situation where the callback wave breaks through the high and low points of the market's starting wave, and it is judged that the trend is no longer a callback but has entered a reversal phase. The pullbacks before the breakthrough are considered callbacks, and the market after the breakthrough is considered a reversal.

The diagram shows an illustration of market confirmation of external reversal.

Looking at the left side first, the red arrows represent the structure of the trend's callback. After the market starts with a bullish move, it forms a pullback. During the pullback process, as long as the market does not break below the starting point, the entire pullback phase is considered a callback. During the callback phase, the trend is always understood as bullish, and we only go long and do not go short.The structure on the upper right side of the chart is the reversal pattern of the market trend. After a continuous upward movement in a bull market, during the process of falling back at a high level, if the market breaks below the starting point of the previous main bullish wave, it is understood that the market is bearish and the trend has reversed.

Therefore, the external reversal means that the correction wave has broken through the high and low points of the main rising wave, and the breakthrough point is outside the main rising wave.

2. Internal Reversal.

Internal reversal refers to the situation where during the process of falling back, the market forms a broken wave structure, and at this time, the trend is judged to have reversed. When this broken structure is formed, the market has not broken through the starting point of the main rising wave. The position of this reversal confirmation is within the main rising wave, hence it is called internal reversal.

The chart is a schematic diagram of an internal reversal.

After a bullish trend indicated by the red arrow on the left, the market begins to fall back. During the process of falling back, a downward broken structure is formed, which is the structure indicated by the blue arrow in the chart. At this point, it is understood that the trend has already reversed to bearish, and the trading direction turns to short. Subsequently, the market reverses and falls.

The concept of the critical point between bulls and bears:

The critical point between bulls and bears refers to the market breaking through a certain point, and the direction of bulls and bears has been switched. For example, the internal and external reversals we mentioned earlier.

The critical point between bulls and bears for an external reversal is whether the market has broken through the high and low points of the starting wave. This point is the dividing line between bulls and bears. For an internal reversal, the critical point between bulls and bears is whether the internal market has broken through the high and low points of the reverse structure. This point is the dividing line between bulls and bears.

For example, to confirm the reversal of the market with a trend line, the point where the market breaks through the price of the trend line is the dividing line between bulls and bears, and this point is also the critical point between bulls and bears.The concept of the critical point between bullish and bearish is introduced to remind everyone that when setting standards to confirm whether the market trend is a pullback or a reversal, you are essentially determining a turning point in price.

Let's discuss the resonance of multiple criteria to confirm whether the market trend is a pullback or a reversal.

In practice, to enhance the success rate and stability of trading, we often use the resonance of multiple criteria when confirming whether the market trend is a pullback or a reversal.

The most representative method is in the "Trend Trading Method," where a market reversal must be established through three indicators: the channel line, the trend line, and the inflection point. If the market breaks through these three indicator points in the opposite direction, it is considered a reversal; before the breakthrough, it is a pullback.

At this point, some friends may wonder, after we have established our own standards for reversals and pullbacks, how should we use them?

I will then explain several examples.

3. Two examples of entry in pullbacks are explained.

First, let's discuss a successful external reversal case; please see the illustration.

The illustration shows a successful external reversal trade, which is a 1-hour candlestick chart of the British Pound to US Dollar.

On the left side of the chart is a continuous bullish trend. At a high point, the pullback trend broke through the starting point of the last main upward wave of the bullish trend, completing the external reversal.At this point, the trend turns bearish, and one should look for opportunities to short. After the market has undergone a series of upward consolidations and forms a reversal candlestick pattern, it is time to enter the market. The stop-loss can be aggressively set above the high point of the reversal candlestick, and then the market falls significantly.

In this trade, the stop-loss point is 20+ points, and the market moved downward by 100+ points, making the risk-reward ratio quite reasonable.

Next, let's discuss a case of an external reversal failure. Please refer to the illustration.

The illustration shows a case of an external reversal failure, which is also a 1-hour candlestick chart of the British Pound to US Dollar.

The structure of the trend in the chart is basically similar to the successful case mentioned earlier.

On the left is a continuous bullish trend. At a high point, the falling market broke through the starting point of the last main upward wave of the bullish trend, completing the external reversal. At this point, the trend can be understood as bearish, and one should look for opportunities to short.

Subsequently, the strength of the upward consolidation was quite strong, and a reversal candlestick pattern was never formed. It was not until a bearish hammer pattern was formed at a high point that the order was entered, with the stop-loss set at the high point of the reversal candlestick. However, the market did not fall back to the order's stop-loss, resulting in a failed trade.

Two similar patterns, one successful and one failed.

By putting these two cases together, I aim to resolve any doubts. All trades are based on assumptions, and whether the market is in a correction or a reversal is also an assumption.

Therefore, we need to establish our own criteria for judging whether the trend is a reversal or a correction. Before the market has reversed according to the criteria, we assume it is a correction in the trade and enter according to the rules. If the market correction ends and continues in the original direction, we profit. If the market does not continue after a reversal, we stop the loss.As long as we control the success rate and the profit-to-loss ratio well, for example, with a 40% success rate and a 2:1 profit-to-loss ratio, our technical standards will have a profit advantage. As long as we persist in implementing them over the long term, we can achieve profitability.

At this point, our focus is not on useless market predictions, but on how to optimize the success rate and profit-to-loss ratio. Trading becomes more reasoned and manageable.

4. Several issues regarding pullbacks or reversals

Question 1: What is the most suitable pullback level for entry?

After the trend has established its direction, it is a common confusion among traders about how much pullback is most appropriate for entry during the market pullback.

In practical trading, sometimes the market starts to move after a simple pullback, and sometimes it starts after a deep and complex pullback.

The Fibonacci retracement indicator is used to reflect the market pullback ratio. On the Fibonacci retracement indicator, the most commonly used pullback ratios are 38.2%, 50%, and 61.8%. Some traders also add 23.6% and 76.4%. With so many ratios, which standard has the highest success rate?

From an execution perspective, it is not advisable to choose too aggressive a standard. In real trading, we do not know how the market will move next. Suppose we enter the market using the reversal candlestick pattern; if we enter when the market pulls back to the 23.6% level and encounter a deep pullback in a consolidation, due to the aggressive entry, we may face consecutive stop losses.

The diagram illustrates the Fibonacci retracement entry. After the bullish trend is established, the market reaches a 23.6% pullback during the decline, and a reversal candlestick entry fails above 38.2%. Subsequently, the market pulls back again to the 50% level, and the second entry is successful.

If we set the trading standard to enter after the market pulls back to 38.2%, we can filter out one incorrect trading opportunity in this trade.Filtering trading signals can reduce the consecutive error rate of trading outcomes, which is conducive to the execution of trades. Therefore, it is recommended that everyone should consider entering a pullback trade after the market has retraced to 38.2% before proceeding.

Additionally, the Fibonacci retracement can be combined with other indicators for entry filtering. For instance, if it is a long entry, one could require the market to retrace to the 38.2% Fibonacci level and also test the lower Bollinger Band before considering entry.

Question 2: The issue of time frames.

All pullbacks and reversals must have a fixed time frame.

For example, a reversal may form on the 1-hour time frame, but on a larger daily time frame, it might just be a pullback. Therefore, in practice, we must select the time frame that belongs to our own trading, and only then consider whether it is a pullback or a reversal on that fixed time frame, without constantly changing.

Today's content mainly teaches everyone how to define the technical criteria for trend reversals or pullbacks. You can then adjust according to your own cycle habits and the details of your trading system, legislate for your trading behavior, and verify its effectiveness. After that, implement your technical standards in a unified manner of knowledge and action, ultimately achieving profitability in trading.