In crypto trading and investment, the number one goal is to not lose money. This can be easier said than done given how volatile the cryptocurrency markets can be. One of the most common mistakes made by new traders and even some more experienced traders is recognising the difference between a pullback and a reversal. To follow along with this article, we’re going to assume you already know how to read and understand a candlestick chart.
What is a Pullback?
A pullback is when an asset’s value lowers temporarily during an upward trend. This is typically caused by short-term traders realising profits after a significant rise and is often seen as a buying opportunity by other investors. The important takeaway is that a pullback is temporary and usually only lasts for a handful of candles before the upward trend resumes. This can easily be spotted on the charts in retrospect but often, in the moment, can be confused with a reversal and cause some traders to miss out on potential gains. A pullback and a retracement are essentially the same thing and the terms are often used interchangeably.
What is a Reversal?
A reversal can look the same as a pullback as it occurs but is a much longer-term movement. Reversals in the stock market are often caused by sudden changes in the perceived value of the security. For example, if a company’s rival releases a product which competes with their best-selling product, investors may start to re-evaluate the value of the company’s share prices. In crypto, something as trivial as a tweet from a high-profile individual such as Elon Musk can massively affect the price, albeit often temporarily. Traders want to avoid recognising a reversal as a pullback because when they realise that it is the former, it will be too late to exit the trade without losing money.
How can I differentiate between Pullbacks and Reversals?
The start of a reversal often looks the same as a pullback. Competent traders learn how to use moving averages and indicators such as the RSI and MACD to gauge the market momentum. Doing this can help to identify whether the move is short-term or likely to go on for much longer. Given that pullbacks and reversals can happen on a variety of different timeframes, what may seem like a pullback to a swing trader may by more like a reversal to a scalp trader. It’s important to do your own research and technical analysis to be an accurate trader. Day trading can be risky if you don’t know what you are looking for.
If you are a beginner, it’s best not to enter a long position based on a pullback. While they can give a good entry point, misjudging a reversal as a pullback would be catastrophic. Small steps are the best way to start to get used to the movements made by the markets based on the analysis you do. Learning how to use technical indicators which display momentum information can give a much better picture of what is happening and, as always, never trade with capital you can’t afford to lose!