"I believe the very best money is made at the market turns. Everyone says you get killed trying to pick tops and bottoms, and you make all your money by playing the trend in the middle. Well for twelve years I have been missing the meat in the middle, but I have made a lot of money at tops and bottoms."
-Paul Tudor Jones
Recognizing the end of a trend takes practice and foresight. Today's article will build upon the FX Trend Trader Series to help you be prepared for the end of the trend.
When you can recognize the end of a trend, typically one of two things will happen. First, a reversal and new trend in an opposite direction can develop, which presents it's own opportunity to traders. Second, a clearly defined yet elongated corrective pattern that you can see and stay away from has many benefits as your time and energy won't be focused on low probability opportunities but rather, on trends that have clearly continued and are worth following.
Defining the Birth of a TrendIt may help to think of a trend as a living thing. A living thing, whether in the market or elsewhere on the planet has a definitive beginning. In markets, the beginning can be marked by a handful of key characteristics. First, a price where the trend has begun, which is usually the death of a prior trend or much larger prior corrective move. Second, a time when the trend has begun is clearly marked on the charts just like the price.
Lastly, a fundamental event that sets off a new trend can be helpful because the echoing of that original theme with price continuing in the direction of the new trend is often proof positive that a new trend has developed.
Defining the Death of a TrendBuilding upon the birth of a trend can help you define the death of a trend.
The three components we just looked upon, price, time and fundamentals can be used as a market to see if what started the trend still holds and if not, then that trend can be counted as dead. First, look at the price that was the death of one trend and the beginning of a new trend. If that price is broken, then the trend is broken.
Second, building upon price, bring together your time preference to see if a trend has lived a typical lifespan and if so, has it also broken the prior price. If you're a day trader, you may be looking at a trend or directional bias over a series of days where as a swing trader would look for a trend that has lasted over a series of weeks or months. Lastly, if the fundamental story that began the prior move has overturned and this has happened after a trend has run its typical course in terms of a time while at the same time, the original price that initiated the trend has broken then we can identify the trend as over.
What To Do When the Trend Has Been Labeled DeadThe toughest time to trade a trend is at the beginning. An oversimplified but helpful example would be to break the trend down into thirds. The first third is the choppiest, and earlier in the trend, you're looking to buy, the less leverage you should use because the more chop you're likely to experience.
The middle third of the trend is similar to the sweet spot. The middle of the trend is the sweet spot because it still has much more to go and the fundamental story begins to confirm the trend, which brings new traders into the trend continuing to push the price. The last third of the trend is the easiest emotionally to trade and can be identified by sideways corrections but is risky because if trend death is near then, you carry on more risk if the reversal is swift and you're unprepared.
The most important lesson here is that trend traders should always be on the look out for the death of a trend.
Once you're reasonably confident the trend has ended, you should trade in the direction of the new trend and look to a different currency pair with a clear developing trend.
Happy Trading!
