Identifying the change of trends

In Part 1 of the Naked Trading 101 series, I elaborated on how price action can be a useful tool to identify what phase the market is currently in. Understanding the phases gives traders a bird’s eye view on market sentiment and how to apply appropriate strategies to trade the markets. 

For Part 2, I will go through in more detail on how to identify the start of a trend or reversals. There is nothing more satisfying for a trader than to identify a trend during its early stages and then simply riding it in the impending direction for a sustained period of time.

To recap a trending market is:

  • Uptrend – a series of Higher Highs (HH) and Higher Lows (HL)
  • Downtrend - a series of Lower Lows (LL) and Lower Highs (LH)

In the examples below, traders who were able to catch the trends in the early stages could actually ride the trend for a year or more! This certainty brings a new perspective to the term ‘the trend is your friend’.

Example 1: Uptrend 2013 - 2015

Source: IG platform

Example 2: Downtrend 2013 - 2014

Source: IG platform

On hindsight, it is simple to identify swings, define a trend, and spot a reversal. However, in order to be a successful trader, it is critical to be able to understand what the market is doing and where it might potentially be heading towards.

As traders, we are in the business of predicting price movement in its infancy and not commenting on the past. Hence, knowing when the market is reversing or whether a trend is continuing is an invaluable tool that traders should have.

Let’s get into some theory now. It might seem rather complicated in the beginning, but once you are able to train your eyes to identify the swings and predict the moves, it will help boost your confidence as a trader. 

How to identify the change of a trend from Bullish to Bearish Reversals

Example 1: Conventional Move

Price goes from a series of Higher Highs (HH) and Higher Lows (HL) to making a failed high, which we term Lower High (LH). A failed high is often the first sign that bullish momentum in context of uptrend is waning.  This will usually precede a Lower Low (LL), which is relative to the previous low that will confirm a potential start of a downtrend.

Source: IG platform

Example 2: Radical Move

Similar to Example one, price initially forms a series of Higher Highs (HH) and Higher Lows (HL). However, in this case, no Lower High (LH) was formed. The price simply breached the last major and obvious swing low to form a Lower Low (LL).  After this, one should expect Lower Highs (LH) to form and a bearish trend to commence or move into a consolidation phase

Source: IG platform

How to identify the change of a trend from Bearish to Bullish Reversals

Example 3: Conventional Move

If price goes from a series of Lower Lows (LL) and Lower Highs (LH) to make a failed low, we term that as Higher Low (HL). A failed low is often the first sign that the bearish momentum in context of a downtrend is waning. This will usually precede a Higher High (HH), relative to the previous high which will confirm a potential start of an uptrend.

Source: IG Platform

Example 4: Radical Move

Similar to example 3, the price goes from a series of Lower Lows (LL) and Lower Highs (LH). However, in this case, no Higher Low (HL) was formed. The price simply breached the last major and obvious swing high to form a Higher High (HH).  After this, one should expect Higher Lows (HL) to form and a bullish trend to commence or move into a consolidation phase.

Source: IG Platform

Now that we are familiar with identifying change of trends, the next step is to go to the live markets and train your eyes to spot reversals and trends on the charts. It is really interesting how price action can serve as a leading indicator to predict future movements as the patterns generally repeat itself all the time.

Keep an eye out for Part 3 where I will elaborate more on how to enter a trade with the trend. I also conduct weekly live webinars which focuses on simple price action, support and resistance on charts. Nothing like learning in the live markets.  Register for the next webinar. 

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