A Simple Tool to Help in Identifying Trend Reversal

There is a great deal of nonsense written about trends and using trend lines. Quite often - and maybe even the majority of the time trend lines aren't even drawn on a trending move and traders then cry when they lose money because of a trade they had based on the break of their line.

To be honest the concept of a trend is really one of the most simple tools in a trader's toolbox but the definition of a trend is normally forgotten and could actually help your trading considerably. Let us just cover the definition of a trend:

• Up trend A sequence of higher highs and higher lows
• Down trend A sequence of lower highs and lower lows

It really couldn't be much simpler than that.

Sometimes - and in spite of the number of lines that traders draw - this doesn't happen very often, a supporting line can be drawn across the lows in an up trend or above the highs in a down trend.

In most cases you can consider trading a break of the trend line. At this point you do have to be a little careful since if the previous low in an up trend (previous high in a down trend) is not exceeded there is still chance that price can go and retest the trend line and occasionally this can be at a new extreme.

You can see in this example how even though the trend line was broken the prior low in the sequence of higher lows was not penetrated. Following this price rallied to retest the trend line twice, the second time at a new high before it finally broke lower. You would normally expect momentum indicators to be showing a divergence at this point.

How can this be used in a practical way?

Well recently in Pro Commentary I had identified a peak in EURUSD that stalled at 1.2902 and I forecast a retracement to below 1.2800 with a favored target at 1.2745. In fact it only moved down to 1.2761. At these times when it is uncertain whether the correction is complete or whether price will move lower to target it is possible to consider the concept of a trend. Here is the 2-hour chart:

Following the break of the sequence of lower highs I confirmed to readers that they should expect to see the up trend resume with support between 1.2790-1.2805 holding and would eventually reach the 1.2976 high and probably later to 1.3180.

While identifying targets of where to find support or resistance requires knowledge of how price develops and the relationships in those moves followed by what sort of correction to expect, the concept of when the correction is complete is actually quite a simple process.

You can use this very simple tool with great effect.