What Is a Reversal Amount?
The term reversal amount refers to the price level required to move a chart to the right. The concept is commonly used in technical analysis, a trading discipline that identifies opportunities by analyzing statistical data such as price and trading volume. The reversal amount is a condition used on charts that only consider price movement instead of both price and time.
Key Takeaways
- A reversal amount is the price level required to move a chart to the right is a concept used in technical analysis.
- Reversal amounts are factors used in technical analysis, a discipline of trading where traders analyze charts and historical statistical data to determine future entry and exit points.
- Reversals occur when a security's price moves in the opposite direction.
- It is difficult to spot a reversal, even for expert strategists and traders.
- Spotting an inflection point and the reversal amount is important to buying low and selling high.
How a Reversal Amount Works
Technical analysis is a method specific traders use to determine the prices of securities in the future by analyzing statistical data from the past, such as trends, prices, and volume. These traders spend a lot of time analyzing charts, making entry and exit points based on the data they review.
This trading method is grounded in the quest for spotting market reversals, be they upward or downward movements from the market's current trajectory. Reversals happen when a security's price moves in the opposite direction. For instance, the price of an asset that moves in an upward direction reverses when it goes down and vice versa.
Spotting a reversal is easier said than done. Psychologically, reacting optimally to reversals can be incredibly difficult for even seasoned technical analysis strategists and traders. In many ways, that's because the market still shows many indications of a continued move in the original direction in the early stages of an actual reversal—not just one that's perceived.
In the context of point and figure (P&F) charts, the reversal amount is the number of boxes (an X or an O) required to cause a reversal. As noted above, the reversal would be represented by a movement to the next column and a change of direction. If you increase the reversal amount, you remove columns corresponding to less significant trends and make it easier to detect long-term trends. In terms of Kagi charts, the amount (generally around 4%) needed to change the direction of the vertical lines.
A point-and-figure chart plots price movements for securities without taking the passage of time into account, while a Kagi chart uses vertical lines to delineate supply, demand, and the price movement of certain assets.
Example of Reversal Amount
Here's an example to show how the concept of a reversal amount works. The market's sharp drop during 2008 was a prime example of a significant downtrend whose conclusion was fairly difficult to pinpoint. In hindsight, the lows of March 2009 are easy to identify. But in the heat of the moment, it was considerably more difficult to purchases equities heading into 2009. This was true, particularly after the market beat up bullish investors in the preceding years.
By the time average investors were confident and piled back into equities, much of the recovery was already baked in, as with most boom and bust cycles. This is why spotting an inflection point, and the reversal amount (or level) is key to buying low and selling high.
