Trend Reversal or Simple Correction?

To trade properly, we need to focus on two major chart components: the trend of the security and the supply or demand zones. The trend tells us when we should be a buyer or a seller. The supply or demand zones tell us where we should actually take action. Mastering how to read these components is part of the Online Trading Academy core strategy.

A bullish trend is a series of higher highs and higher lows. A bearish trend is when you have lower highs and lower lows. When the trend shifts from bullish to bearish or vice versa, we see that definition of the trend broken by price. But how it breaks may offer a clue as to how far the new movement may travel before a large reversal.

When looking at the reversal of a bullish trend, we know that the trend is officially over when lower lows are put in. But if price makes a lower high before making the first lower low, then it shows the lack of buying pressure in the markets and a larger likelihood that the resulting bearish trend will be stronger.

As seen in the preceding picture, when price breaks to a new low first before making a lower high, the breakdown is likely to pause and retest before continuing. It could even have a much shorter movement downward before reversing again. This is typical of a price correction where the trend was only temporarily interrupted.

The BBBY chart shows where the end of the uptrend and start of a new downtrend was indicated by the lower highs and lows.

Breaks of the trend definition without defining a new trend first are a potential sign of a correction. In the AAPL chart, price did reverse trend according to the strong signals. However, when a higher high came into a downtrend without higher lows first, it was simply a correction and offered a new opportunity to short in the bearish trend.

When price makes a lower high before the lower low, it is usually a sign that the trend is actually reversing.

The same strategy is true for bullish reversals of a downtrend. When there is a higher low put in first before a higher high, then the rally is more likely to continue as the sellers have given up and buying pressure has been building. But if the higher high is made before a higher low, you are likely to see a correction and retest of the breakout. You may also see a weak bullish trend resulting from this.

The initial intraday trend for the SPY on the following chart was down. A trader who noticed the higher low preceding the higher high would have known that the trend was reversing and longs were now the better opportunity.

The signal works most of the time regardless of the timeframe used. In the following daily chart, a bearish trend reversed with higher lows before higher highs.

This technique is to be used as an odds enhancer. The trends will typically reverse at strong supply and demand zones from larger timeframes. The corrections occur at supply and demand from the smaller timeframes.

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