Recognize and profit from trading trend exhaustion without using indicators
What to look for and how to attack when the market shows these 3 keysSigns of trend exhaustion and how to take advantage of it. No indicators needed!
If you can properly identify exhaustion trading trends, it is one of the best times to capitalize on a moving market.
The phenomenon occurs when most traders trading in a certain asset are too long or too short. This leaves a handful of investors ready to move on to the other side of the transaction.
The exhaustion of the trend could indicate the investment of a current trend as it shows that there is excess supply or demand, indicating that the market is overbought or oversold.
In this article, we will describe 3 ways to identify trend exhaustion on the chart without using any indicator and how you can use it to profit in a changing market.
Measured impulse waves
Once your eyes are trained to spot these trends, they will be nearly impossible to miss. All prices move according to momentum and corrective waves. Therefore, recognizing and knowing which one is coming next will help you predict what price is likely to come next.
Simply put, measured impulse waves are only significant price movements. They can be upward movements in bullish trends or downward movements corresponding to bearish trends. It is important to note that there are no time constraints when it comes to these patterns. Some waves can last for hours, while others continue for years or even decades. No matter the time frame, waves will always move in the same direction as the trend to a greater degree.
In the example above, you will notice how impulse waves have trends associated with them. An uptrend in an impulse wave will continue to rise because the jumps up are larger than the incremental moves down, which occur between each of the large price increases.
The small moves down between the big gains are called corrective waves.
Trend trading and riding the wave
To take advantage of impulse waves, you need to trade in the direction that they are trending. This is because the price is making the biggest moves in this direction. The chance of making a big profit is therefore higher when trading impulse waves than smaller corrective waves. Corrective waves are a good point to enter a trade.
If this starts to remind some of you of a surfer catching a big wave and riding it to the finish, it’s because it’s a similar idea. He catches the trade in the smallest corrective wave and rides it to its height and peak as a wave of momentum. You can then sell short the next corrective wave period to take advantage of the next impulse wave that is likely to come.
Another good idea that impulse waves offer is the ability to predict quite well when a trend is going to change direction. For example, when looking at a graph, if you notice large bullish moves with small corrective waves followed by a larger bearish move, it is a good indication that the bullish move is trend has ended or is about to end. Similarly, if you see a downtrend with a sudden large move up, the trend is now likely to be up, and if you are trading trends, you should be preparing to buy during the next corrective wave.
This is not so much a standalone point but rather a secondary part of the general introduction to impulse waves. This section discusses the composition of impulse waves to give you a better understanding of which to recognize the patterns.
As you will have recognized in the image of the impulse waves, each wave is made up of five smaller waves that make a net movement in the direction of the trend of the next largest degree. This is the most common pattern that impulse waves are seen in and the easiest to spot on your chart.
In the image above, you can see that of the 5 waves, three are “motive waves” (upward trending waves) and two are “corrective waves” (downward trending waves). This is the simple structure 5-3-5-3-5. While it is simple in composition, there are 3 rules that guide its existence. If any of these rules are broken, it cannot be an impulse wave and must be relabeled.
3 rules for a wave:
- Wave two cannot retrace more than 100 percent of wave one.
- Wave three can never be the shortest of waves one, three, and five.
- Wave 4 can NEVER cross into the same price area as wave 1.
Overtime prices change, and when we look at these changes compared to prices in the past, we get what is known as a momentum change.
If we look at our charts and notice that prices are changing rapidly, this means that momentum is high and it is likely that a large number of traders are buying or selling assets to push the price change in any desired direction. In relation to impulse waves and trends, momentum is calculated simply by taking the slope of the trend line.
To trade momentum swings, we need to consider the overall action being taken. As mentioned above, when momentum is high, many traders buy a certain asset to influence the price. On the other hand, if the momentum is very low, it means that the asset is oversold.
For an attentive trader, signals to buy appear when momentum is very low, but then quickly shoots up through the zero line. Similarly, signals to sell appear when momentum is very high and then rapidly drops below the zero line. Savvy traders view these movements as a strong indicator of the price movements of any given asset and a barometer of the overall health of the market.
The bottom line on depletion of trading trends
Trend trading and capitalizing on trend exhaustion is something any smart and prepared trader can do. While it takes some time to learn to recognize patterns and fully understand the mechanics behind them, once the knowledge is incorporated into a trading plan, it can give an already strong trading strategy a huge boost.
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