Trend Reversal Recognition Using a Line Chart
Stock Trading strategies based on Swing Trading or Long Term Investing ideally look for entry points with the lowest risk for new positions.
One method is to look for Trend Reversals.
A Trend can be recognized on a chart by drawing a line connecting two or more high or low points to determine of prices are rising or falling.
The problem with using only this method by itself, is that trend reversals with 2 connecting points occur all the time, and continuously.
Money is always flowing back and forth and exchanging hands.
If prices continued predictably in one direction for an extended period of time, life as a trader and Investor would be easy.
So What Can We Do To Lower Our Risk? One technique is to look for a combination of higher highs AND higher lows for an up trend, or lower lows AND lower highs in a down trend.
Instead of just connecting 2 points between lower lows on a chart for example, and saying we are in a down trend, only to watch prices reverse and move much higher, waiting for a second lower high to connect between lower highs will add additional confirmation of the larger degree trend in place.
Example 1) In the basic, higher risk method first mentioned, if prices are continuing higher and are at $25.
00 and a pullback occurs to $24.
00 and then begin to move higher again, we have 1 low point at $24.
00.
If prices move up to $24.
50 and then move lower again to $23.
00 before moving higher, we now have 2 lower lows to connect a trend line between- $24.
00 and $23.
00.
This would form a falling, bearish trend line.
After bouncing from $23.
00 prices now move up to $26.
00 before pulling back.
Prices made a new high, yet we thought we were in a down trend.
Example 2) Same as above, except that when prices bounced higher from $23.
00, they only went up to $23.
50 before beginning to decline again.
We now have a downward sloping trend line between $24.
00 and $23.
00 that is connected between lower lows, AND an additional downward sloping trend line connected between $24.
50 and $23.
50 forming lower highs.
This second confirmation lowers our risk of entry for a short position to the downside.
Once we have our confirmation of trend, we now can look for our optimal entry point, as there are several options here as well.
One method is to look for Trend Reversals.
A Trend can be recognized on a chart by drawing a line connecting two or more high or low points to determine of prices are rising or falling.
The problem with using only this method by itself, is that trend reversals with 2 connecting points occur all the time, and continuously.
Money is always flowing back and forth and exchanging hands.
If prices continued predictably in one direction for an extended period of time, life as a trader and Investor would be easy.
So What Can We Do To Lower Our Risk? One technique is to look for a combination of higher highs AND higher lows for an up trend, or lower lows AND lower highs in a down trend.
Instead of just connecting 2 points between lower lows on a chart for example, and saying we are in a down trend, only to watch prices reverse and move much higher, waiting for a second lower high to connect between lower highs will add additional confirmation of the larger degree trend in place.
Example 1) In the basic, higher risk method first mentioned, if prices are continuing higher and are at $25.
00 and a pullback occurs to $24.
00 and then begin to move higher again, we have 1 low point at $24.
00.
If prices move up to $24.
50 and then move lower again to $23.
00 before moving higher, we now have 2 lower lows to connect a trend line between- $24.
00 and $23.
00.
This would form a falling, bearish trend line.
After bouncing from $23.
00 prices now move up to $26.
00 before pulling back.
Prices made a new high, yet we thought we were in a down trend.
Example 2) Same as above, except that when prices bounced higher from $23.
00, they only went up to $23.
50 before beginning to decline again.
We now have a downward sloping trend line between $24.
00 and $23.
00 that is connected between lower lows, AND an additional downward sloping trend line connected between $24.
50 and $23.
50 forming lower highs.
This second confirmation lowers our risk of entry for a short position to the downside.
Once we have our confirmation of trend, we now can look for our optimal entry point, as there are several options here as well.
