Changes in the trend
A fundamental aspect that very few traders dominateis how to determine when a trend is nearing its end and about to change to start a new trend. The turning point in which the change in the trend´s direction occurs is known as trend reversal. In many times the traders often find themselves in situations where they do not know if a trend will continue or reverse, for example when the market is in a lateral trend (the price moves without a defined trend).
In these cases these traders do not know if the trend is in a period of respite, gathering strength to continue its movement or the market is at the beginning of a possible change in trend direction. In these and other similar situations the trader does not know whether to continue backing the current trend or wait a significant change in it. An error in this aspect can lead to large losses if the trader is not careful.
In order to identify the end of a trend the trader should watch carefully important price levels such as resistances, supports and maximum and minimum which are reached during the movement of prices. Normally, during an uptrend, prices tend to produce higher highs and minimum that each time are successively higher than the preceding minimum. If we observe a high which is lower than the previous high and breaks down the trend line, this is a clear sign that this a possible reversal in the market trend (of course this is a high probability signal which does not have 100% reliability since it can be simply a temporary reversal in the trend).
For this reason the trader should always be alert to the behavior of the highs and lows produced by the price over time. To identify possible changes in the trend we must remember the following basic principles:
- In a downtrend line (the line is drawn by joining the successive highs forming the downward movement) the breaking and the trend reversal occur when the price forms a new high that breaks the trend line.
- In an uptrend line (he line is drawn by joining the successive lows forming the downward movement) the breaking and the trend reversal occur when the price forms a new low that breaks the trend line.
It is important to note here that these principles are not 100% sure as anything related to financial markets. It may happen that in a particular trend, the prices do not reach new extreme levels (maximum or minimum) for a period of time, without this necessarily mean that the trend has ended and will reverse. It does not even mean that the trend will end soon. Many times, a trend that for the moment does not produce higher highs (bullish trend) or lower lows (bearish trend) and that seemed about to reverse, sudenly continue with the prevailing trend as it did before. For this reason the trader must be very careful when trading with a possible change in trend.
At other times the price of a certain asset which had behaved according to a specific trend, manages to reach an extreme level which makes traders believe at the moment that the trend is not going to change, and suddenly, prices begin to move in the opposite direction with strength. If this occurs at the same session, it is called a reversal day. This can occur regardless of whether the trend at that time was bullish or bearish.
The days in which reversals occur indicate a radical change in investor sentiment (especially in major reversals) or a change in the balance of power between buyers and sellers, which is what occurs at the end of a market movement no matter if this movement is bullish or bearish o large or small. An strong change in the balance of power between buyers and sellers can cause that a market movement stops which may signal the birth of a new trend in the opposite direction.
The days of reversal may involve a major change in the trend of prices in the market for the short-term and sometimes the medium term. If this happens, the reversal day is also called reversal key day. It is important for the investor to ensure that it is a reversal key day, for whichthe analist should study the market conditions during the previous days. The trader should also use other cues necessary to determine with greater certainty whether this constitutes a reversal key day. These keys are:
- That day the trading volume has been higher than the previous sessions.
- If the reversal was from a bullish trend to a bearishtrend, the highest level of the session must be lower than the highs of the previous sessions before the price finally begins to fall strongly.
- If the reversal was from a bearish trend to a bullish trend, the lowest level of the session must be higher than the lows of the previous sessions before the price finally begins to rise strongly.
It is important to distinguish when a trend will reverse to avoid being trapped in a losing trade unnecessarily.