TREND REVERSALS
MOST SUCCESSFUL TRADES OCCUR IN THE
DIRECTION OF THE TREND
The advantage of trading with the trend is that it is the direction
traded by large scale traders and the momentum caused by new money entering the
market is likely to continue moving prices in the direction of the trend until
there is a good reason for it to turn around. The reason could be a fundamental
event or simply profit taking. Below are several ways to determine trend
direction.
TREND REVERSALS
Chart 12 - Since the trend is the direction
of the next longer dominant cycle than the one you are trading, the beginning
of an uptrend is often confirmed by a buy signal in the next longer time frame.
In the weekly chart at the two lows indicated by W, the direction of trend for the daily chart was confirmed when prices exceeded the high of the weeks with the
mechanical signal dots.
Another indicator of an uptrend is that the
trading cycle highs and lows in the daily chart are above the previous trading
cycle tops and bottoms. Following an uptrend, a drop below a previous trading
cycle bottom will most often indicate the end of a trend and is likely to be
followed by a period of consolidation or a downtrend.
TREND INDICATORS
EMA Trend Indicator
Chart 13 - Moving averages turn slowly, but
can be reliable trend indicators that accurately show trend. These indicators
will reverse direction slowly, but
using them in a pattern with mechanical entry signals and 38% – 62%
retracements can give high probability cycle trading pattern signals.
The weekly chart that follows shows two
exponential moving averages (EMA). When the faster (thicker) moving average is
moving up and above the slower
(thinner) moving average the trend is up, and when it is below the slower
moving average and moving down, the
trend is down.
EMA%
Trend
Chart 15 -
An oscillator can be created by calculating the percentage difference between
the thicker line and the thinner line. Plotted below prices it is also a trend
indicator, showing a slowdown of the uptrend and indicating a trend reversal by
the turn downs at A and B. Trend reversals can be followed by a
downtrend as at A, or consolidation
as at B as the weekly cycle drops
into a bottom before continuing higher. While cycle bottoms in consolidation
can be bought, the safer trades occur when the EMA% Trend is moving up.
MACD Trend Indicator
Chart 16 -
Another popular indicator that shows the trend well is the MACD. Plotted at the
bottom of the chart below, the points where the thick line crosses the thin
line show the potential for a trending move to continue. When both the MACD and
the EMA trend indicators are moving in the same direction, the odds strongly
favor a trending move
Chart 17 - Plotting these weekly trend
indicators on a daily chart gives a clear picture of the direction to trade.
The chart below shows weekly trend indicators overlaid on a daily chart, with
trading cycle tops and bottoms indicated by the arrows.
KELTNER CHANNEL
The Keltner Channel can be used on charts of
any time frame, and is very useful as a component of a Cycle Trading Pattern
when calculated in the time frame used to determine trend.
Chart 18 - In the daily Tbond chart below,
the trading cycle tops and bottoms are indicated by the arrows; the weekly
cycle tops and bottoms by the "W"s.
A 5-week moving average is plotted on the daily chart and the Keltner Channel
is plotted 1.1 standard deviations above and below this moving average. Both
the moving average and the standard deviation can be modified.
When buying bottoms in the direction of trend
the biggest moves often have a "rubberband" effect following an overextension
to the downside. After meeting resistance
at the upper channel line, a drop below the moving
average would be an overextension if prices remain above the lower channel line
basis the close. In our chart example, a drop below the moving average followed by an RSI3M3 mechanical buy
signal above the lower channel line
occurred at six trading cycle bottoms. All were followed by sizable upmoves.
Notice that the price lows and trading cycle bottoms occurring above the moving average line had much
smaller upmoves in price and often in time.
At times, an uptrend can be inferred by prices
meeting resistance at the upper channel line, then dropping into a trading
cycle bottom below the moving average, but above the lower channel line.
Category: Methods of technical analysis
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