From the January 01, 2012 issue of Futures Magazine • Subscribe!

How to identify price trend reversals

Laying the foundation

A trend is price movement, plain and simple. As long as groups of people have gathered together to trade stocks, cattle, horses, real estate or any good, price trends will emerge. Price will then go up, down or consolidate between two price levels until an outside force enters the market to force one of those dynamic actions to change.

To analyze price movement, you must be able to classify it in one of three time periods: Short-term, intermediate-term and long-term. Short-term trends last from a few minutes to a few days; intermediate-term trends last from a week to several months; long-term trends last from several months to years.

In addition, trends will begin to form depending on whether the underlying security is under active accumulation or distribution (see "Market modes," below). Accumulation occurs when a stock or commodity is being acquired by a sufficient number of investors and the market reflects a gradual increase in price because of rising demand. This is indicated by a steady series of higher-highs and higher-lows.

Conversely, distribution occurs when a stock or commodity is being sold as a sufficient number of investors liquidate their holdings. That results in a gradual price decline as demand for it falls, leading to a steady succession of lower-highs and lower-lows.

If price is not exhibiting either of these behaviors — upward movement or downward movement — then it is consolidating in a trading range until an imbalance is created in either supply or demand, and will remain in consolidation until either the bulls or bears gain control and force a trend to emerge. The game changer then is where an external force, or catalyst, enters the market and changes the dynamic of the direction of the trend that will be revealed in the trend’s price action.

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