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Trading stocks education - Trading tactics & examples

A Change in Trend, Part 1

How to identify a change in trend from a
strong uptrend to a base or possibly a downtrend


One of the most common mistakes for traders to make, both new and old alike, is trying to short a strong stock just because it is strong. It "has to" turn around soon… Like wise, some will try to buy a weak stock just because is weak. It "can't" go any lower… This article will help you look for signs of when the strong rally, or fall may be ending.

Example is of a strong rising stock, and when to tell weakness has set in. Keep in mind that everything applies equally to the reversed situation, with a weak falling stock. Take a look at the example below.


chart courtesy of Mastertrader.com

Above is a daily chart of HGMCY. The blue line is the 40-day moving average. The red line is the 20-day moving average. The strait green line is a trend line that was drawn in manually. This stock has been in what we call a strong stage 2 uptrend on the daily chart from March until the beginning of June. This is evidenced by the fact that the 20 ma is in an uptrend, the 40 ma is in an uptrend, and we have the 20 above the 40 in parallel fashion. We have a clear series of higher highs and higher lows.

Notice that on all pullbacks, the 20-day moving average has worked as support. All pullbacks to this area were buyable. Any shorting attempts during this rally are low odds, and have small targets. When you fight the trend, you are always fighting for a piece of the "small move" rather than the "big move" in the directions of the bigger trend.

The green trend line is drawn in for a reason. When this uptrend line is broken, it puts us "on notice". We are to watch the new highs and lows. Notice a few clues on this chart in the area marked with the number 1. First, notice the large red bars - distribution bars. Large selling. Notice the volume, heavy. This is the first area that breaks the downtrend, and also breaks the 20 ma, which has held every prior time. These are clues. Notice that the break of the trend line was "questionable". That is not an issue, because we are not acting here, just watching.

We are now watching for a lower high. We get it at point 2. After that, an aggressive trader can look to short the sell setup that occurs on the daily chart at number 2, or to use the next rally to short on a daily sell setup (less aggressive). Advantage could be taken of this situation by shorting the gap up that occurred on June 7, under the 5-minute low.




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