2-Step Reversal

There are several price patterns to which I pay special attention when they arise. Some of them, like the 2 Close Reversal, are pretty common and provide useful guidance at any point in time. Others appear with far less frequency but are extremely effective when they do.

A patient trader, or one who is only looking to trade a few times a year, might choose to simply wait for this type of pattern for trade generation. This is particularly true since this indicator is more prevalent at intermediate turning points. However, as with any indicator, a large enough sampling of trades has to be taken before the true value of any indicator can be accurately assessed.

With that said, let’s move on to the discussion of the 2-Step Reversal. The 2-Step Reversal is similar to a Turn-Key Reversal in that it involves a key reversal up followed by a reversal down followed by another key reversal higher.

The main distinction is that the intervening reversal down (or up in a topping 2-Step Reversal or Turn-Key Reversal) is NOT a key reversal in the 2-Step Reversal, while it IS a key reversal in a Turn-Key Reversal (see 4th bar from the left in each diagram above).

Another distinction involves the initial key reversal higher (center – or 3rd – bar in both diagrams). In a Turn-Key Reversal, the initial reversal is a key reversal, but often NOT a 2 Close Reversal. In a 2-Step Reversal, the initial reversal IS a 2 Close Reversal as is the second reversal as well (5th bar from the left in each diagram). This is why the 4th bar is not a key reversal, or any form of a valid reversal, but merely a ‘pullback’ from the initial reversal’s close.

In many cases, the support for the second low-and- reversal point (5th bar) is what was 2nd Close Support during the 4th bar’s decline. In other words, if the intervening decline had been a key reversal lower, this point (the close of the 2nd bar, preceding the initial reversal higher) would have been the 2nd Close to confirm a 2 Close Reversal sell signal. (See Eric Hadik’s Tech Tip Reference Library for additional details, filters and diagrams.)

Consistent with the rules for a 2 Close Reversal, this close is viewed as support on the 4th day even before a key reversal has emerged. The difference is that it is carried over to the next day as support in the case of a 2-Step Reversal.

This pattern is consistent with Elliott Wave principles, since it is in effect a 1st wave advance, 2nd wave decline and start of a 3rd wave advance. As a result, the market often accelerates higher immediately after the completion of this signal.

Due to the double reinforcement of this pattern, it is stronger than many other reversal patterns and triggers a 3 – 5 period (day, week, month) signal as opposed to simply a 1 – 3 period signal.

Learn more about the 2-Close Reversal in Eric Hadik’s Tech Tip Reference Library.