The tricky thing about speculating on trends is that the very notion of a trend is a projection of something past folded into the present. In other words, it’s something of a paradox, but that’s beside the point.

Essentially, you can’t predict the future regardless of the quality of fundamental or technical data you may have. And that’s why trading and investing fall under the category of “speculation.”

But it is possible to read a few “signs” that may hint at the possibility of a weakening trend, or a new trend formation; signs that may point the way to a possible reversal or change (e.g. toward a more sideways ranging movement).

And although technical setups may at times seem very clear cut, we recommend that you support your technical thesis using fundamental data which, in the end, is what moves price.

Remember, technical signals don’t move economic factors; but economic factors move price, and by extension, technical signals.

 

How Can You Spot Potential Trend Reversals and Changes Using Price Alone?

Take a look at the price chart below. This is a Daily chart of the DJIA from November 2017 to June 19, 2018.

 

trend-change-1-300x233 Identifying Trend Reversals Using Price Action

As you may know, the Dow had peaked on January 26, 2018, after which it began a fairly large-sized correction, enough to make any trader or investor wonder whether the uptrend had come to an end.

Despite the Dow’s inability to move beyond its January 26 high around 26,610, we also noticed that it had tested and failed to break below its February 2 low of around 23,778.

And between this peak and trough, we see upward movement yet again; something of a micro uptrend that is happening both between a large uptrend (from March 2009 to the presen) and a short term correction—a correction that may signal an uptrend continuation, extended period of sideways movement, or a trend reversal.

Given these three possibilities—up, sideways, and down—and given that nobody can be absolutely certain as to which way it will eventually move, especially in light of the economic and geopolitical events taking place, how can we read the price movements to position ourselves for potential trades?

 

Using Simple Trend Rules to Seek Tradable Opportunities

Here’s a simple contextual overlay that you can use to interpret what is going on with price.

 

trend-change-2-300x233 Identifying Trend Reversals Using Price Action

Note the color scheme:

  • Black = trend undecided
  • Red = Potential Downtrend
  • Green = Potential Uptrend

We begin at (1), the January 26 peak before which the “correction” had started. We see the correction bottoming on February 8 at (2).

So now, what’s next? Is the uptrend still intact, or are we heading toward a change (possible a trading range) or a trend reversal? Since we can’t predict the future, we need to focus on shorter term technical movement and follow a few basic trend principles.

For the long-term uptrend to continue, price must break above (1). If the beginning of a downtrend were to materialize—whether short-term or long-term—the first indication would be for price to break below (2).

What happens? Price failed to reach the peak, so we interpret (3) as a signal for a potential change or reversal. We colored it red assuming a bearish bias (operative word is “assuming”).

But next, price failed to break below (2), and stopped at (4). Now, we are unsure as to whether this signals a bearish move or a move toward consolidation, hence (4) is colored black.

Price rises but fails to break above the previous swing high, so (5) is considered a potential downtrend and we’re expecting it to break below (4) which it does, establishing a new swing low at (6) which matches the low at (2).

The Dow establishes yet another lower “high” at (7) confirming our downtrend bias.

But then, it fails to establish a lower swing low, instead bouncing off the same price range as (2) and (6) which, in effect, establishes a strong support level. We will refer to this as (8), and our downtrend bias is now, once again, in question.

Suspecting that a strong support had been established, we now wait to see if the previous swing high will be violated, which would change our expectations from downtrend to potential uptrend or ranging motion.

Price establishes a new higher high at (9), signaling an uptrend bias which is supported by its higher low at (10). And as expected, at least according to our rules, price establishes a swing high at (11) which is higher than the previous swing point. We now have an uptrend bias.

This brings us to the present day. Will the next swing low remain above (10)? And if it does, for the short-term uptrend to continue, price must now establish a higher swing high point above (11).

Anticipation is not Prediction

This may have seemed tedious to some of you. But if you really want to look at price trends from an objective and rule-based framework, this is one way to do it.

What’s better is that this way of viewing trend helps eliminate a degree of loose prediction by following what you see on a measured basis.

This way of seeing things may not be predictive but takes you to a close point beyond which you can only speculate.

 


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