Preschool>= Lesson Status ?
Kindergarten>= Lesson Status ?
Elementary>= Lesson Status ?
Grade 1 Support and Resistance Levels
Grade 2 Japanese Candlesticks
Grade 3 Fibonacci
Grade 4 Moving Averages
Grade 5 Common Chart Indicators
Middle School>= Lesson Status ?
Grade 7 Important Chart Patterns
Grade 8 Pivot Points
Summer School>= Lesson Status ?
High School>= Lesson Status ?
Grade 9 Trading Divergences
Grade 10 Market Environment
Grade 11 Trading Breakouts and Fakeouts
Grade 12 Fundamental Analysis
Grade 13 Currency Crosses
- What is a Currency Cross Pair?
- Crosses Present More Trading Opportunities
- Cleaner Trends and Ranges
- Taking Advantage of Interest Rate Differential
- Obscure Crosses
- Planning Around News and Fundamentals
- Creating Synthetic Pairs
- Euro and Yen Crosses
- How to Use Crosses to Trade the Majors
- How Cross Currency Pairs Affect Dollar Pairs
- Summary: Currency Crosses
Grade 14 Multiple Time Frame Analysis
Undergraduate>= Lesson Status ?
- Why Keep a Trade Journal?
- Benefits of Keeping a Journal
- What Should You Record in Your Journal?
- Potential Trading Area
- Entry Trigger
- Position Sizing
- Trade Management Rules
- Trade Retrospective
- Trading Journal Statistics
- Reviewing Your Trading Journal
- Difficulties of Keeping a Trade Journal
- Summary: Keeping a Trade Journal
Graduation>= Lesson Status ?
- Which Trading Style is Best for You?
- Which Currencies Should You Trade?
- What is Your Level of Trading Experience?
- Should You Be a Discretionary, Mechanical, or Hybrid Trader?
- What Kind of Mechanical System Suits Your Personality?
- What is Your Attitude Towards Risk?
- What Kind of Stop Suits Your Trading Style?
Measuring the Strength of the Breakout
As you learned earlier, when a trend moves for an extended period of time and it starts to consolidate, one of two things could happen:
- The price could continue in the same direction (continuation breakout)
- The price could reverse in the opposite direction (reversal breakout)
Wouldn't it be nice if there was a way to know to confirm a breakout? If only there was a way to avoid fake outs...
You guessed it.... THERE IS A WAY!
In fact, there are a couple of ways to tell whether or not a trend seems to be nearing its demise and a reversal breakout is in order.
Moving Average Convergence/Divergence (MACD)
By now you should have a good foundation of the MACD indicator. If you don't, you might want to check out our lesson on MACD.
MACD is one of the most common indicators used by traders and for good reason. It is simple yet dependable and can help you find momentum, and in this case, the lack of momentum!
MACD can be displayed in several ways but one of the "sexiest" ways is to look at it as a histogram. What this histogram does is actually show the difference between the slow and fast MACD line. When the histogram gets bigger, it means momentum is getting stronger. When the histogram gets smaller, it means momentum is getting weaker.
So how can we use this when trying to spot a trend reversal? Glad you asked!
Remember that trading signal we talked about earlier called divergences and how it occurs when the price and indicators move in the opposite direction? Since MACD shows us momentum it would make sense that momentum would increase as the market makes a trend. However, if MACD begins to decrease even when the trend is continuing, you can deduce that momentum is decreasing and this trend could be close to an end.
You can see from the picture that as price was moving higher, MACD was getting smaller. This meant that even as the price was still trending, momentum was beginning to fade out. From this information, we can conclude that a trend reversal is highly likely.
Relative Strength Index (RSI)
RSI is another momentum indicator that is useful for confirming reversal breakouts. Basically this indicator tells us the changes between higher and lower closing prices for a given period of time. We won't go into too much detail about it but if you would like to know more check out our lesson on RSI.
RSI can be used in a similar way to MACD in that it also produces divergences. By spotting these divergences, you can find possible trend reversals.
However, RSI is also good for seeing how long a trend has been overbought or oversold. A common indication of whether a market is overbought is if the RSI is above 70. On the flipside, a common indication of whether a market is oversold is if the RSI is below 30.
Because trends are movements in the same direction for an extended period of time, you will often see RSI move into overbought/oversold territory, depending on the direction of the trend.
If a trend has produced oversold or overbought readings for an extended period of time and begins to move back within the range of the RSI, it is a good indication that the trend may be reversing.
In the same example as before, the RSI showed that the market was overbought for a billion days (ok not that long). Once RSI moved back below 70, it was good indication that the trend was about to reverse.
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- Trading Breakouts
- Ways to Measure Volatility
- Types of Breakouts
- Spotting Breakouts
- Measuring the Strength of the Breakout
- Trading Fakeouts
- Fade the Breakout
- How to Trade Fakeouts
- Summary: Trading Breakouts and Fakeouts