The most basic definition of a trend is based on the high and low prices of an instrument. Above is the daily chart of MU but it could be any stock, ETF, index or commodity. Virtually all price charts exhibit the same patterns and behaviors! Let’s start at number 1 on the chart. As you move forward in time you’ll see the development of a downtrend with a low at 1, a high at 2, a lower low at 3 and and a lower high at 4. Easy right? Wait a minute… it’s only easy to see that 4 was a lower high because we’re viewing the chart in hindsight but when was it actually proven to be a lower high in real-time? Not until price made another new low at 5. That then confirmed 4 was a lower high and so I should’ve gotten short at 5 because it confirmed another leg lower in the downtrend…right? Ok, how would that have worked out? ☹ As it turned out the low of the day at 5 was a great location for a long (bullish) trade, not a short (bearish) trade. You’ll see this failed breakdown over and over again across all charts. Price drops below a prior pivot low and causes traders and investors to sell or get short because they think price is heading even lower and then that allows the large size buyer’s to take the other side of the trade and get into their bullish positions at a bargain price. Then the inevitable rally begins. I’m often able to avoid that bad trade location by using a price clue to speculate that 4 was likely going to end up being a lower high as of the close of that very day’s candle! The daily candle, while green, had a long upper wick which is often consistent with a reversal candle. However, that’s just one data point because reversal candles often turn out to not be reversal candles when the next day’s price continues higher. The more reliable signal to me is that the potential reversal candle came with a spike above and a close back below the declining upper band of the 8 SMA. That is a very common setup and you don’t have to look further back than the high at number 2 to see the almost identical setup!
So how about a price clue that the number 5 daily candle on July 27 was a likely failed breakdown that would lead to a rally? For that I drop down to the 60-minute timeframe chart below. The hourly 8 SMA bands work the same way as they do on the daily timeframe. When the bands are declining the upper band is a good location for a short trade since price should find resistance there and move lower. The close of July 27 was right at the declining upper band so the next day’s price action should have been lower. However, the next day saw a gap up open and price didn’t reverse and head lower. Instead, it continued to rally indicating that the buyer’s were more motivated than the seller’s. That’s important information to have as a trader! The rally continued with all of the candles closing above the now rising 8 SMA bands.
So there you have it. Take what you’ve learned here and go look at some other charts and see if you can find this type of price action elsewhere. If you can’t you’re not trying very hard! If you have a question or comment let me know.