Markets often shift to neutral near the end or reversal of a trend. Furthermore, there are often subtle changes in momentum before reversing direction. Talented traders have a knack for identifying when momentum is waning. Here are several ways to identify when a trend has reached exhaustion.
Subtle Changes Reveal a Shift in Bias
During a rally it is common to see the low price of the day within the first hour of the session. And in a bear market the daily high price is often reached in the first 60 minutes. When the opposite activity occurs, it signals a subtle shift in bias. As a trend higher swings to neutral, the high for the day tends to print in the first hour. Conversely, the opposite occurs near the end of a down trend, where the daily low prints early in the session.
Intraday Signs of Impartiality
Another indication a trend is near completion includes a series of 3 to 5 sessions where both the high and low of the day are made after the first 60 minutes of trading. This sign of impartiality is often accompanied by decreasing volume and day range length. Markets are created to facilitate trade, so if volume and ranges dissipate while a market moves in a direction it will typically turn and head the other way.
There are a couple of common candlestick patterns that show up when a trend is weakening. A small body candle (a.k.a. doji) signifies balance. These candles have similar opens and closes and a series of them over 3 days to a week is common before a market reverses.
Momentum Candles
Markets move higher until prices are attractive to sellers and lower until buyers are enticed. Another candle called a hammer shows up frequently just before a reversal in trend. A bull hammer typically has a long wick near the bottom of a range with a short candle body near the high. A bear hammer has a long candle wick starting from the top of a range and a small candle body near the low. The rule is a hammer wick is twice the length of the body of the candle. Hammers appear at the end of trends and are common at the onset of a new trend.
Another clue a trend is exhausted is range length. Most charting packages have an option called ATR or average true range. Use a short-term measurement between 10 and 15 days as a benchmark. When range length dips below average over 3 to 5 consecutive sessions a change in trend often follows.
Sector Correlations and Change
Sometimes subtle changes turn into a significant difference. Make it a point to track correlations between treasuries (interest rates), equity indexes, foreign exchange, precious metals and energy. A subtle change in metals often has an impact on the dollar, which may be connected to interest rates that could affect equity market prices and even energy levels.
Use Signals to Enhance Timing for Entry and Exit
The combination of consecutive sessions with severe price overlap, decreasing volume, small candle bodies and below average ranges is an indication of trend exhaustion. When these components are identified, it is a warning to take profits, hedge your bet to endure a consolidation phase or countertrade a trend.
John Seguin
Senior Technical Analyst
Market Taker Mentoring
