This video looks at how to identify a trend change, and trend changes are important because that is where most people lose money. Determining the trend direction is also where the money is made.
No doubt about it, this will be one of the most boring 14-minute segments of your life, but also crucial to your trading. Determining how to identify a trend change in real-time is something a lot of traders struggle with. They wait too long, wanting a trend to really establish itself, at which point it is already likely to reverse. Or, they get in too early hoping to pick a top or bottom.
In this video I show exactly how to identify trend changes in real-time, so you can capitalize on the ensuing trends and trades.
This material is covered in The Forex Strategies Guide for Day and Swing Traders along with strategies for how to capitalize on these trends and shifting markets. If you are more interested stocks this topic is also covered, more in-depth, in my Stock Market Swing Trading Video Course.
How to Identify a Trend Change – Video
At the start, I mention that this video is based on (portions of) Chapter 6: Trendlines, Horizontals and Shifting Markets (this video was recorded in 2013…I will update it soon!). In the latest version of the book, that chapter is now Chapter 10. This video also briefly touches on some other concepts, such as velocity and magnitude, which is a very important concept even though I don’t directly talk about it in the video.
Also, I highlight some possible trades. The transition up is one people often struggle with. The price barely makes a lower low, and then makes a higher high. The price then moves sideways. I say that a trade can be taken if the price breaks higher (out of the sideways pullback). Some may say that there is no uptrend there, and struggle to take that trade. They struggle because at the exact moment of the trade, it doesn’t really look like an uptrend. But rememeber, we are only taking a trade if the price breaks out of that pullback/consolidation to the upside. If that occurs, we will have a higher high a higher low (from before), and the price has started moving up again when we take the trade. That indicates the price is likely heading higher and we should be involved.
Notes on Trends and Reversals
If the price is making overall lower highs and lower lows, that’s a downtrend. When the price makes a higher swing high that often indicates a reversal could be underway. If it is followed by a higher low, that helps confirm the reversal (and that a trend could be forthcoming on the upside).
If the price is making higher lows and highs, that’s an uptrend. When the price makes a lower swing low, that often indicates the price could be reversing to the downside. If this is followed by a lower high, that helps confirm the price is likely heading even lower.
The above relates to monitoring price action, but doesn’t tell us when to actually trade. For more on a reversal trading strategy, see the Strong Trend Reversal Strategy.
I primarily only focus on trading strong trends (or reversals using the strategy mentioned above). Once a trend shows weakness I usually stop trading that trend. Once the trend weakens, I either leave that asset alone or wait for a reversal signal to occur. Once the reversal occurs, I may not trade right away. The price reversal just tells me what direction I will be trading in if a trade setup occurs.
How do we know a trend is weakening? By looking at the size of impulse waves relative to the corrective waves. When a trend is strong, the impulse waves are much bigger than the corrective waves. As a trend weakens, the impulse waves get smaller relative to the corrective waves. For example, in an uptrend, the price will barely make a new high before falling again. That shows the latest impulse to the upside was barely bigger than the correction that preceded it. It doesn’t mean the trend is over, but it has weakened.
Trends are fickle. Sometimes they last a long time and sometimes they don’t. Analyzing trends takes constant work, especially if day trading. You may have a beautiful trend one moment, but then it shows signs of reversing the next. The new trend may then reverse just as quickly. Or a trend may weaken only to strengthen again. That’s trading. We just keep adapting our view based on what the market is telling us through our analysis. If we can’t get a good read on which direction the market is trending, or the trends are weak, then we don’t trade.
Finally, the big picture determines our trade direction, but the small moves are what usually provide our entry points. Just because the price is dropping doesn’t mean we blindly sell it. In my case, if the price is dropping I usually wait for a pullback to the upside, and then I start watching all the price bars (the small price wiggles). I already know I am going short because of the downtrend, but by zeroing in and analyzing each price bar (and compare them to each other) on the correction I can see when the buying momentum is starting to fade and therefore I can look for opportunities to get into a short trade. So we can’t only focus on the minor and small movements, and we also can’t only focus on the big movements. To get really good at trading we focus on both: the bigger picture for determining trade direction and the smaller “wiggles” for finding great entries.
For more on forex trading, see the Forex Strategies Guide for Day and Swing Traders eBook. If you are interested in longer-term trades, which only take about 20 minutes a week to manage, then check out the Forex Strategies Course For Weekly Charts.
By Cory Mitchell, CMT