Identifying a trend reversal using graphical patterns

No matter how much advice a trader hears about the advisability of trading in the direction of the trend, however, sooner or later he will be drawn to look for a trend reversal. And it is not surprising, because the successful identification will allow not only to maximize the income by opening a position at the beginning of an emerging trend, but also to assess all the charms of position trading.

trend reversal

Finding trend reversal points

A successful long-term trade will allow for some time to forget about the need for a daily search for new favorable opportunities and to surrender to the elements of the market, guided by one single principle: "let the profits grow".

In this regard, many famous traders have repeatedly tried to develop the concept of reversal. Who does not remember the principles of trend reversal on 1-2-3 pattern Victor Sperandeo, or the criteria for the veracity of Thomas Demark's trendline breakthrough? Linda Raschke with her "Three Indians" and Thomas Bulkowski with his "Splash and Turn with Acceleration" and many other world-renowned authors have not escaped similar studies.

They include Joseph Stowell, who developed a model known as the "three-bar line". According to this pattern, the truth of the trend cannot be questioned until the market tests the horizontal line, identified by the minimum value of three increasing bars or the maximum value of three decreasing bars. In this case the peculiarity of their formation are consecutively rising (falling) extremums.

Using the "Three Bar Line" with the ADX indicator

Many trading strategies have been developed based on this concept, many of which favor different indicators. Today we will consider the possibility of using curves together ADX indicator and the above methodology.

Futures on the dollar/ruble pair
Futures on the dollar/ruble pair

Market overheating can be identified by the +/- DMI lines reaching the next extremes. On the daily chart of the futures on the currency pair dollar/ruble this has happened three times in almost two years. And twice it was followed by a reversal.

The extreme value for -DMI can be detected experimentally (in the above example it is 60), and the break of the three bar line is an important element of trend reversal identification.

In February 2011 and July 2012 a successful test led to a change in the trend, and in August 2011 the lack of a breakout led to a continuation of the trend. Let me remind you, the line is constructed using Bars, whose maximums are rising relative to the previous ones. The line is drawn through the minimum of the first bar marked on the chart as point 3. The given marking allows to simplify the process of model search: the market peak is used as bar #1.

Combination of patterns to identify a market reversal

Knowing the skeptical attitude of many traders to indicators, it is possible to build a trading system without their participation. For this purpose, a combination of two graphical configurations is used: Joseph Stowell's "Three Bars" and the "1-2-3" model. Studies in various markets have shown that a known pattern can be formed after a break in the line under study, which gives grounds for making a trade.

Platinum futures
Platinum futures

On the platinum futures chart, the location of the "Three Bars" line corresponds to the correctional low of the "1-2-3" pattern, testing of which led to a reversal bullish trend.

As a confirmation signal may be used the dynamics of volumes, which emphasizes the weakness of the market. The fact is that in conditions of rising quotations, the return to the upward movement after the correction is usually accompanied by increasing trading volumes, as buyers are not willing to miss the exhaustion of the pullback in order to open longs at favorable prices. If this does not happen, then the trend is not as strong as it might seem at first glance.

It should be noted that the point 3 of the model "1-2-3" may be below the line of three bars, but before the complete formation of the pattern, you should ignore the pre-existing signal, or use other confirmations of the reversal of the current trend.

Other articles about the peculiarities of using graphical patterns

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