The Hindu Business Line : Trader's Corner

Anyone who has spent more than five years watching the stock markets would know that initiating that perfect short position at the market’s peak or going long at the trough is an elusive dream. Trepidation and nervousness caused by linear thinking invariably holds one back from going against a strong trending market.

In fact, it not really prudent to jump in and initiate a trade counter to the market trend just because a voice in your head is telling you to do so. Though such intuitive acts might give you a windfall from time to time, it can also result in a steep drawdown of your trading account.

It would be better to wait for firm trend reversal signals from the charts before initiating trades against the trend. The most widely followed tool for identifying a trend reversal is the trend line. If the trend is down, the down trend line is drawn by joining the peaks formed during the down move. A firm break-out above the down trend line would be a sound reversal signal. In an uptrend, the price should move below the trend line joining the troughs to signal the trend reversal. A spurt in volumes along side the trend reversal should help to confirm the signal.

Another method to ensure the end of the prevalent trend is with the aid of moving averages. The popular moving averages are the 10-day moving average, the 21-day moving average, the 50-day moving average and the 200-day moving average. The stock price moving above the moving average line after a down trend would be construed a buy signal whereas the stock price closing below a moving average after an up-trend will be a sell signal.

The moving average lines crossing each other are also considered as buying and selling signals (more about that in later columns). And of course, there are the plethora of chart patterns such as rounding tops and bottoms, double, triple tops and bottoms, head and shoulders etc. to signal trend reversal. Japanese candlesticks study throws up a series of reversal patterns too. — Lokeshwarri S.K.