Every trader wants to ride a trend. The trend is your friend, right?
That’s true all the time. But, there’s a catch.
The Forex market doesn’t trend that much. I mean, it sure does, but what seems like a trend, turns out reversing when no one expects.
From a money management point of view, traders overcome a reversal by trailing the stop. However, this ends up exiting on the first swing against the primary trend.
Or, in a trend, there no such thing as a straight line. The market moves and corrects. After all, this is the very definition of a trend.
Namely, connecting two points. But, those points appear when the market corrects the primary trend.
Simple Way to Spot a Trend Reversal
How do traders know when a trend ends? Or, when a new one starts?
Typically, what traders do is to wait for the main trend line to break. While this is correct most of the times, it often gives false signals.
What if I told you there’s another, more exciting way, to look for a trend reversal, without even using a trend line? Here’s how.
Take Clues from the Previous Trend
Because the market moves in waves, the move of the primary trend gets to be corrected by smaller counter trend ones.
Effectively, this means that in a bearish trend, the moves in the main trend will make lower lows, while the counter-trend moves will make lower highs.
For as long as this series of lower lows and lower highs holds, the trend won’t reverse. No matter what fundamental analysis or some other kind of study points to the upside, the trend will keep going.
In a bullish market, the upside moves will see the price continually making higher highs. At the same time, the pullbacks won’t break the previous low.
That’s a bullish trend, and the market won’t reverse until the series of higher highs and higher lows ends. As such, the first clue that a trend will change is when the market breaks the previous trends last lower high or higher low.
Let’s look at the EURUSD recent daily chart. For the whole summer of 2017, it moved aggressively, in a bullish trend.
However, before that, traders could have spotted the previous trend’s reversal. Just use the same steps explained above, and you’ll end up with the chart below.
From left to right, the market formed a bearish trend. And, the most recent lower high held on the first bullish attempt.
However, the second attempt saw the EURUSD breaking the previous lower high. That’s bullish, as it signals a new trend started. Or, it shows the previous one ended.
As such, to respect the new higher lows and higher highs series that corresponds to a bullish trend, the previous higher low must hold.
How about a trade? When can traders go long?
For this, we need a trend line. Just connect the first two points of the new trend line, and when the price hits the line, that’s the perfect place to buy.
Because the previous higher lows must hold, that’s the stop loss. As for the take profit, look for a risk-reward ratio that is bigger than 1:3.
Considering this is the daily time frame, this simple price action technique gave excellent results.
Technical analysis doesn’t have to be complicated. Traders often get lost in so many indicators and trading theories that they forgot the bread and butter of technical analysis: trend reversals and trend riding.
As always, price action comes to help. Only use the logic of lower lows and lower highs in a bearish trend, and higher highs and higher lows in a bullish one. You’ll be on the safe side of the market.