Trend Reversals at Trade10.com- The science of trading market momentum for stocks, options, futures and bonds.

Critical Day Analysis

Our critical day analysis is all about trend reversals. We tell you when there is a high potential for a reversal of the short trend and we've been doing it since 1994 with an 80%* accuracy.

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Trend Reversals

A trend in tradable securities is identified by a prolonged movement of price in a specific direction. Trends can be of various sizes. A longer term trend represents the largest pool of like minded valuation beliefs among investors. A change in direction of the longer term trend usually indicates a larger and longer movement of prices in the new direction once the change occurs. Shorter term trends represent smaller pools of like-minded valuation beliefs and a reversal of a shorter trend is expected to be of smaller and shorter consequence in the future path of prices. Trends that reverse all share common characteristics. One such characteristic is the breaking of trendlines that are generated by past price price activity. A trendline is a line drawn to connect the peaks of price or the troughs of price. It represents previous turning points in the path of prices during the formation of the price trend currently in place. Trendlines running along the troughs of price are called support levels. Trendlines that are generated from the peaks of price are called resistance levels. A price trend that reverses warns traders to adjust portfolio's in light of the perceived change in supply and demand for the underlying tradable security. As an example, a rising price trend that falls below its rising trendline warns that weakness in price may be developing. An appropriate response may be to exit long positions, reduce exposure or to hedge the position. Alternatively, traders may adjust current strategies or leave them unaltered if the time horizon of their investments does not necessitate action for a perceived shorter period reversal. Other trade possibilities include speculative activity in buying put options, short selling or futures if they are available. Certainly a caution is that while every price trend reversal produces a penetration of a key trendline, not every penetration of a trendline is followed by a price trend reversal. Below are a look at various methods developing supporting evidence of price trend reversals.

GE Example 1

General Electric was moving with the rest of the markets in a rising price trend on the graph prior to December 2000. The trendline in red on the graph was not generated until well into the development of the rising price trend and is used primarily to develop a warning sign should the price trend begin to falter. Longer term trends are a result of the fundamentals in the economy and for the company. Warning signs of a weakening trend that coincide with a weakening of fundamentals supports the perception that a price trend reversal may occur. A trigger point for many investors in looking for evidence of price trend reversal is the use of trendlines. When price penetrates a trendline the possibility exists that a reversal in price trend may occur. Most investors wait for a 5 to 10% percent move through a trendline to avoid the possibility of whipsaw. A whipsaw occurs when penetration is followed by a move back above or back below the penetrated trendline.

AOL - Example 2

In looking at a short term trend as in the chart of AOL, evidence of price trend reversal can be found first in penetration of the shorter term trendline in red. The sideways movement in price in the week following the trendline penetration is a warning that investor enthusiasm may not be strongly in place. To add to evidence for outlook of enthusiasm in the new direction of short term price trend we often look at the longer term price trend for overall bias. For AOL, the longer term price trend was falling during the period shown in the chart to the right. A longer term chart of AOL is shown below. A rising longer term price trend may support a more optimistic price projection for a shorter term trend reversal that is expected to move higher. The MACD at the top of the graph is an indicator provided on most charting software. It provides signals when the MACD (solid line) crosses its 9 day moving average (dotted signal line). Rising above the signal line indicates a buy signal. Falling below the signal line indicates a sell signal. When markets are trending sideways, the signals of the MACD may cross several times in a short period of time necessitating that any anticipation of a reversal of price trend should be supported by a wide body of evidence. In addition the MACD is produced by moving averages and as such, lag changes in price. During the period of the graph, AOL was in a longer term downtrend, inviting a cautious approach to price projections once a reversal of price trend was suspected in the graph above (October/November 2000).

Guidant Corp - Example 3

The Chart of Guidant Corp to the right shows trendline penetrations (1), divergences (2) and high volume point typical of exhaustion selling (3). The number 1 on the chart shows a penetration has occurred both on the MACD indicator and price. Penetration of a support trendline warns that prices may fall in the future. The number 2 on the chart below shows a divergence between the troughs of price and the troughs of the MACD indicator. When divergences occur between the peaks or the troughs or both at the same time as is the case with Guidant Corp, it warns that a reversal or resolution to indecision may occur. The warning allows us to look for supporting evidence in order to properly assess price trend expectations. The number 3 indicates a high volume period. During extended periods of selling, a high volume point often occurs at a reversal point in price trend. It is often referred to as exhaustion selling and typically includes a high volume of late selling into the decline and early buying into the next leg of price trend. Exhaustion selling together with divergences and trendline penetrations, provide stronger supporting evidence that a price trend reversal may be occurring.

Trend reversals are often preceded by divergences in various momentum indicators, or by breakouts from price patterns or patterns on an indicator, or by a breakout from a trading range or support/resistance zone. There are many advance warning signals that the tools of technical analysis provide.

Our critical day research was created to pinpoint high probability days when a reversals of the short trend could occur. When we refer to short trend in association with critical day analysis, we refer to the shortest segment of price leading into and away from a critical day. Take a closer look at our research.

To the right technical studies are examined in more detail to provide a sense of conformational evidence for traders of the critical day. Click on any of the terms to take a closer look at a technical discussion on that topic. All formations, patterns, indicators and technical tools fail at various times and so should only be used to build a body of evidence in forming a trading decision rather than being solely relied upon. There are a number of valuable studies that lead to intuitive understandings about price and volume but a strong compliment to technical analysis is an understanding of the trends and changes in the fundamentals and economic activity that ultimately lead valuation levels in the markets.

Walk through a critical day

The graphs show a price plot of the Dow Jones Industrials from Sept 28/00 to early November. The First graph ends on November 3/00, two days before an upcoming critical day on November 7/00. Our members looking at the market are expecting a trend reversal to occur due to the high rate of success in our research. Ideally a member will be using their own skills to judge the supply and demand changes, using technical and fundamental indications to confirm suspicions of a reversal, and trade accordingly.
On the second graph we see that the price action on November 6 was a bullish day, reversing the short trend so that the short trend leading into the critical day is now up. A critical day is an expectation of a reversal of the short trend that immediately precedes the critical day. In the case of the November 7 signal, given to members 3 days before, is an indication that the upward moving trend, recognized at the close of November 6 is expected to reverse direction.
On the third graph we can see that November 7 was a low volatility after a large gain on November 6 of about 160 points for the Dow Jones Industrials. The subsequent move over the three days following the November 7 signal saw the Dow Jones Industrials fall 376 points. The next day, November 13, the Dow Jones Industrials lost an additional 83 points with intra-day low a full 609 point loss since the open on the critical day.

Most recent signals

A closer view of the most recent signals. You can see the short trend immediately prior to a successful critical day, reverses coming away from the critical day. Often a failed critical day will indicate a stronger bias in the market for continuation of the trend that was in place prior to the critical day. A failed signal can therefore provide as much information and opportunity as a successful one. Take a look at tech studies to develop a sense of trend reversals and use.

Tech Studies

Comparative Relative Strength

Congestion Pattern

Consolidation