One of the main reasons most traders lose money when day trading is because they are constantly trading against the trend, or counter trend trading. You have probably heard it many times, that the trend is your friend, but what does this really mean? Today we are going to discuss how to reliably predict trend reversals using price action. Believe it or not, there is a fairly easy, but very reliable way to predict trend reversals using simple trend lines. That’s right, the old reliable trend line is very useful to not only find the current trend, but to also signal you when that trend is likely ending, or at least likely to go into an extended correction. There are some very specific rules that we use to determine this, and they are really simple rules and tools that anyone can learn to to use properly with a little time and experience.
So when you hear the long time saying that the trend is your friend, it’s really one of the most reliable trading motto’s out there. Where the problem lies or where most inexperienced traders get tripped up with the trend is that they don’t understand the rules, and they don’t understand how to use the trend line to determine when the trend is in play, or when the trend is actually ending and will begin correcting. Today we are going to show you how to solve this age old problem so that you will completely understand how to use a trend line to keep you on the correct side of the market. Like anything in trading, nothing is ever 100%, but this will work and give you accurate signals more than 90% of the time, which is more than enough to make a living as a trader. At the very least, you can follow the trend using our rules until you get the ending signal, so there is nothing that will require you to begin trading in the opposite direction. Your goal may be to only stay with the trend as long as it’s in play, so you have that option as well.
Let’s go ahead and discuss the trend line rules as we use them in our price action trading. Normally when we are looking for a trend line, we will draw our lines off the first two swings. If the trend is going up, we look for the first two swings of the low and draw our trend line off of that. If there is more than two swings, you can usually find the trend rather easily. If there are only two swings, you might need that third swing to come into play to verify that your trend line is drawn correctly. If the trend is going down, we just reverse these rules to the down side, by finding the first two swings off the high and start with that. You can often verify your line is correct by copying it and dragging it to the lower side of prices on the way down or the higher side of prices on the way up, as there is usually a very clear channel with two parallel lines that will hold prices. The more touches and bounces you get off a trend line, the stronger the trend and the more reliable the trend line.
Once you have your trend line and hopefully you find the entire trend channel, then you will want to enter any time you get a nice reversal bar off the trend line. If the trend is up, we are only interested in buying bounces off the trend line. If the trend is down, we are only interested in selling reversals off the trend line. That’s simple enough, and most traders, even less experienced ones probably understand this part of the equation, as it’s really straight forward. We never counter trend trade, so if the trend is up, we are only interesting in buying and if the trend is down, we are only interested in selling. No matter how good a counter trend entry appears, we are not interested in it in any way. Remember, the trend is your friend, so you want to stay with the trend, even if the trend doesn’t look that strong.
At some point, prices will break the trend line, but guess what? Even then, we are still looking for with trend entries. We will have to be a little more selective when entering with the trend after a trend line break, but even still, we never want to counter trend trade until there has been what we call a retest of the former high in an uptrend, or the former low in a down trend. This is a very critical piece to our trend line rules, so make certain that you understand this part. Normally when you get a trend line break of a proven trend line (meaning there are multiple touches that confirm or prove it), prices will still turn back with the trend and go on to make a new extreme that was higher than the previous one that occurred before the trend line break. In most cases, you will see two clear legs to a new extreme, and less often you will see only a slightly new extreme. Very rarely, prices will not be able to make a new extreme, so you will get a double bottom or a double top on the retest. If the trend was very short term or a micro trend line, you may only get a retest of the actual trend line before prices start correcting.
What’s most important though is that you understand that a break of the trend line is only a clue that the trend is about to end. It does not signal that the trend is actually over. The trend will not actually end in most cases until after a retest of the extreme with a new extreme in place. When we talk about the break of a trend line, we are talking about a clear break where you get a verifiable close outside of the trend line. A few stems sticking through with no closes outside the trend line is normally not enough to signal that that trend may be ending. Once you get a clear break of the trend line though, watch for the retest and stay with the trend as long as you can. Also, it’s important that we clarify that a break of a trend line and a completed retest does not always indicate that a new trend will begin in the opposite direction, although this is very possible and common. The rules state that you will get a correction that lasts at least an hour or so if trading intra-day charts, so you probably don’t want to start trading in the opposite direction until you get a verified trend line in that new direction.
I’m going to add a video to better explain and to demonstrate some of these trend lines and trend channels in action so you can see what it looks like on an actual trading chart. I will use today’s trading chart so that you will know that I didn’t just go out and cherry pick a chart to prove my rules are reliable so be sure to watch the video that is included just below this article. If you are interested in learning how to reliably predict trend reversals using prices action, or learning more about how we use pure price action to trade any chart reliably and with the odds stacked in our favor, then you have come to the right place. You can find all of our price action trading manuals which are located at http://priceactiontradingsystem.com/pats-trading-manuals.