Thursday, July 14, 2011
Trendline breaks end the trend but do not imply reversal
When the trend accelerates (b40-b46) after a sufficiently large move (b13-34), the resulting deep trend channel line violation (b46,47) will usually give a strong snapback move. The deeper the incursion, the stronger the snapback (b47-49).
When counter-trend traders are able to make a very strong move such as the snapback above, the result is a trend line break. Often, the break is obvious without the need for an actual trendline. This show of strength is usually sufficient to pause the trend for a while, however it may not reverse the entire trend right away. This is because at the point of the trendline break (b49 high), sellers will want to sell at a better price and the buyers who missed out will want to buy at a better price. The result is a test of the trend extreme (b47 low) or at least a test of the entry bar (b48 low). A second strong buying at this point will often but not always cause the trend to reverse.
This implies that most entries should exit when the snapback pauses and swing entries should wait for the test of the prior extreme.