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There is a difference between potential trend change and actual trend change. Potential trend change tells you that there is a strong likelihood that the trend could change, actual trend change tells you that the trend has already changed and would be the focus of your attention. In my last two commentaries I spoke about identifying the trend and identifying actual trend change. So now let’s focus on potential trend change.
So, how do you tell them apart? That is what we use technical analysis for!
There are many indicators that point to potential trend change, or instance, candlestick formations. Candlestick formations are a single candle identifier of potential trend change. Formations such as the Hanging Man, Shooting Star or Engulfing candle could point to a possible shift from a bull market to a bear market. Formations such as the Hammer, Inverted Hammer or an Engulfing candle could point to a possible shift from a bear market to a bull market.
Also consider different charting patterns to indicate potential trend change. Patterns such as the Head and Shoulders or Double Top/Bottom show that the market has reached a barrier that has proven difficult to pass and may likely reverse.
Of course, to add to the mix, are multiple variations on moving averages and momentum indicators to signal market exhaustion.
I would not begin to place priority on one over the other. All have their place in identifying trend and potential trend reversal. However, I would suggest that compounding indicators increases the likelihood of making the best decision possible.
What does compounding indicators mean? Good question!!
Think of these indicators a bricks in a wall. One brick does not make a very good wall. Two bricks…….is getting better. Three bricks and you are now forming a pretty good barrier. The more bricks the better.
Let’s look at an example of potential trend change.
Click here for NZDUSD Chart
On the NZDUSD the trend has been up since March 16th. Not too hard to see that now in hindsight. But as I have pointed out in previous posts, the trend can and will change at some point. On this chart you can see that the market reach a point of resistance on April 17th and pulled back about 180 pips. Today, April 20th it has rallied and testing the highs once again. This retest of the high is the first point in which potential reversal could begin. For whatever reason, the market has found a barrier around the 0.8000 area and is having difficulty pushing higher. At this point there is fairly low risk for sell opportunities because the risk is the break of the high. But again, this is only potential because anyone who has traded for any amount of time could tell you that it could just as easily break and move to a new high, which of course IS the direction of the current trend.
Next, on the 4 hour chart, the last candle could be defined as a Shooting Star candlestick formation. Investopedia.com defines a Shooting Star as “……..the formation must be on an upward or bullish trend. Furthermore, the distance between the highest price for the day and the opening price must be more than twice as large as the shooting star’s body. Finally, the distance between the lowest price for the day and the closing price must be very small or nonexistent.”
So that being said we have a second brick in the wall, so to speak. First the Double Top then the Shooting Star. These are both indications of potential trend change. If the market presents additional indicators even better!
To confirm actual trend change I will refer you back to my previous post.
Happy Trading!
Ross Mullins
