Watching the financial media for advice on when a trend is ending is like having a smooth connecting flight at the Atlanta airport—neither is likely to happen. Analysts typically analyze what has long since passed. Once the market has fallen 40 %, only then do they call it a bear market. So much for timely advice. The trick is to utilize tools that provide an objective bias for a trend change while it is occurring, not well after the fact.
Although the following method is not foolproof by any means, it can at least give you enough information to make an informed decision. The setup involves using two indicators from the thinkorswim® from TD Ameritrade trading platform: the 8-period (yellow line) and 21-period (white line) exponential moving averages (EMA), and the Heikin Ashi bars, which are represented by the colors red and green (see Figure 1). A red bar means that the average closing price of the prior 6 bars is in the lower 50 % of its range, indicating a bearish bias. The opposite is true of the green bars. What's nice about this indicator is it takes into context a group of bars—not just a single bar. A group shows a trend change, a rotation from a bullish bias to a bearish bias and vice versa. A single can be an anomaly.
The Secret Sauce
What I'm looking for are two opposite-colored bars as my initial “heads up” that the trend is over. Next, I look to the 8- and 21-period exponential moving averages. If the 8-period starts to roll over, I'll tighten my stop to just below the current price action. For example, at point #1 in Figure 1, there is a choppy trend up and we see two red bars develop. Although there were other red bars during this move higher, this is the first time that the red bars also coincided with an 8-period EMA that has started to roll over. At this point I move up my stop to 4% below the current price action.
Once the 8- and 21-period EMAs cross to the downside, I consider the trend over. And if I haven't been stopped out at this point, I get out. This is useful because it indicates an overall change in trend, which is not an appropriate time to add to a position or double down—it's a time to clamp down on money management techniques.
At point #2 we see a new uptrend beginning. Shortly after the 8- and 21-period EMAs cross higher, confirming a new uptrend has started, there are three red bars in succession. Is this a heads up that the trend is suddenly over? Note that during this time the 8-period EMA does not roll over, so there is no need to raise your stop.
Only at point #3 do we get multiple red bars and a rolling 8-period EMA. Again, this is where the money management techniques are initiated, and it's pretty much “rinse and repeat” from there.