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2B Reversal Definition

Fade the Break

When we have a mean reverting market, breakouts and breakdowns can potentially be false signals. But how do we know when an attempt at a trend has truly failed?

This is a technique called the 2B reversal, also known as a failed breakout pattern.

Initial Conditions

So what do you need? First, there has to be a super clear level that everyone is watching. This is normally a psychologically important level or a key price support area.

Next, you want to see a clean breakdown underneath that level.

Trade the Trader

Now consider the underlying psychology here. Everyone with a copy of Edwards and Magee will be salivating at the possibility of a larger trend forming and they hop on board. We will also see stops run as well as the media talking about measured moves off this pattern.

And in fact, they may be right and we see a true trend develop.

But the 2B gives us an opportunity to fade if they were, in fact, wrong.

So you've seen the break. On the candle that broke that captain obvious level, draw a line at the high or low of that candle.

The setup goes: if we get a reversal back above that high, then the breakout "officially" has failed. From there you can position for a move back inside the range as those looking for the large move are forced to close out their positions. If you're smart, you can structure an options trade in this fashion-- the 2B reversal is an option trading setup thouroughly discussed in OptionFu.

Like all patterns, this too can fail. We may see a break, a failure, and then a reattempt in the direction of the break that can be successful. But the good part about this pattern is you can clearly define your risk.

This setup works on all timeframes, and there's variations that you can use to suit your trading style-- think about what you can do with a failed gap up above clear resistance or reversals above key moving averages. In mean reverting markets you'll have plenty of setups derived from this trading pattern.

by Steven Place

Steven Place is the founder and head trader at investingwithoptions.com/