Analysis Toolbox – End of Trend Market Reversals

by Jody Samuels

This article in The Trader’s Indicator Series discusses end of trend market reversals, which is also an integral component of the trader’s toolbox and crucial for manual trading. The previous article discussed trend lines and channels, an important segue into this topic.

In the last series, called The Trader’s Pendulum, we took you through the 10 Habits, all aimed to support a successful trader. Your mission in developing these habits is to get out of the Technical Trader’s Trap and transform into an Entrepreneurial Trader so that you can start being accountable to your trading. We invited you to take action and begin your journey by completing the Trader’s Scorecard (www.fxtradersedge.com/scorecard) and to get down to business by arranging a free coaching session. In this Indicator Series, we talk about the mechanics of trading.

Trend Lines and Channels for Market Reversals

Trend lines can also be used to target and confirm where a breakout or reversal could take place. This can be extremely useful and provide great entry and exit points for a trader. Trend lines can be drawn on any time frame but using Daily candle charts would be the best starting point for capturing the broad trends.

Notice there are channels within channels. In the chart example we have highlighted the major channel, as well as the minor channels within the major channel. When the price breaks the trend line, usually a new channel establishes itself in relatively short order. This signals a trend change and therefore, a trader may consider trading in the new trend direction once the new trend is established.

The minor channels depict minor trends or short-term corrections of the major trends. At the end of every cycle, price reverses, and that is the start of a new trend within a new channel.

End of Trend Confirmations

There are two broad categories of chart patterns: Continuation and Reversal. Reversal patterns occur at the end of a trend, while continuation patterns occur during the trend and are merely pauses or consolidations in the trend. Several things occur at market reversal points. At market tops, traders and investors are greedy and at market bottoms, they are fearful. Both sentiments lead to market extremes.

There are several end of trend confirmations, which include reversal chart patterns, trend line breaks, reversal candlestick patterns, and divergence using an oscillator. Some common reversal chart patterns include double tops and bottoms, head and shoulders, and rising and falling wedges, which we will not describe here. One-point worth mentioning however, is that the longer it takes for the pattern to materialize, and the larger the pattern, the further the prices will travel once the reversal pattern completes.

At either extreme, there is a major trend line break. In addition, price tends to deviate from the moving averages, so look for price to bounce back to the moving averages at these extremes. Certain candlestick patterns also emerge at the end of the trend and this is where you tend to see long wicks and reversal patterns such as bullish and bearish engulfing patterns, morning and evening stars, hammers, shooting stars, and tweezer tops and bottoms. Finally, the end of the trend is also confirmed by divergence.

If your mission is to become a trader or investor who stays out of the Technical Trader’s Trap, then take the leap to grow into an entrepreneurial trader.

I created the FX Trader’s EDGE Coaching Program modelled after the “10 Habits of Successful Traders”, which is the title of my newly published book by Wiley.

Excerpted with permission of the publisher John Wiley & Sons, Inc. from The Trader’s Pendulum: The 10 Habits of Highly Successful Traders.  Copyright (c) 2015 by Jody Samuels.  This book and ebook is available at all bookstores, online booksellers, and from the Wiley web site at www.wiley.com.

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