As the saying goes, “the trend is your friend.” But how do you know when the trend has come to an end?
There are 7 common methods that professional traders use to identify the end of a trend. They are: support and resistance, parabolic moves, using trend indicators, Elliot Wave, price action patterns, momentum analysis and trader sentiment.
Remember that nobody knows exactly when a trend will end, but these methods will increase your chances of exiting a trade with a healthy profit.
First, I'll show you the basics of how to identify a trend, because you cannot define the end of a trend, if you don't know that you're in a trend to begin with.
Then I'll get into the 7 ways to identify the end of a trend.
These methods can be used in any market. But as always, be sure to do some testing and figure out what works best for you and the market you trade.
You can use the one method that you like best, or use a combination of methods.
How to Identify a Trend
In order to spot the end of a trend, we have to know that we are in a trend first. So let's take a minute to define what a trend looks like.
There are many ways to define a trend, but I like to keep things simple. I'll give you the 2 most basic ways to tell that you're in a trend.
Use the method that makes the most sense to you.
Price Action Trend
First, you can just look at the price action and look for higher lows in an uptrend, or lower highs in a downtrend. The angle of the move will also be steeper than usual.
Here's an example of a bullish trend in the EURUSD. Notice the sharp upward angle, where every pullback is higher than the previous pullback.
The pullback levels are marked with a blue line.
In a downtrend, you'll see the opposite. Each subsequent high is lower than the previous high.
Second, you can use multiple moving averages to define a trend. A common set of moving averages that traders use is the following:
- 20 EMA (blue)
- 50 EMA (green)
- 200 EMA (purple)
In an uptrend, the moving averages should be stacked in the following order, from top to bottom: 20, 50, 200.
When there is a downtrend, the moving averages will be stacked the opposite order. Here's an example.
You can use the moving averages as entry and exit points for trades. I'll get into how to use a moving average to exit a trend in a bit.
But for now, understand that moving averages can be a great way to visually identify when you're in a trend.
Support and Resistance on Higher Timeframes
The easiest way to predict when a trend might come to an end, is to look at support and resistance levels on a higher timeframe.
For example, if you're trading on the 1 hour chart, you might look for levels on the daily chart. If you're trading on the daily chart, you can look for levels on the weekly chart.
Be sure to look for major levels and don't get caught up in every single minor level.
I like to use a 4 chart setup to track levels on multiple timeframes at the same time. This way, I don't miss any levels before entering a trade.
I track the following timeframes:
- 1 Hour
- 6 Minute
Here's what my setup looks like. TradingView makes it easy to do this.
It can be done on MetaTrader, but it takes a lot more work to set up templates and workspaces.
When you see price approaching a major level on a higher timeframe, be prepared to exit, or at least take some of your profits off the table.
Extreme moves, especially to the upside, are not sustainable. Therefore, whenever price goes straight up, that means that there will eventually be a correction.
This principle works especially well in the cryptocurrency markets and with penny stocks because they are prone to “pump and dump” moves.
Here's an example from a penny stock.
But you can also find parabolic moves in other markets.
Forex currency pairs can have parabolic moves in either direction because the currencies in each pair are inversely correlated.
So if one currency has a strong move upwards, then the pair could have a strong move downwards, depending on how the pair is quoted.
When a trend does go parabolic, you don't know exactly when the move will end. Therefore, a good way to exit is to scale out.
Split up your position into 3 or 4 levels and exit part of your position when price hits those levels.
For example, let's say that you have 1,000 shares of stock and you want to break up your exit into 4 pieces.
When price hits each of the levels on the chart, you'll exit 250 shares. If price misses a level and drops to a previous level, then that's probably a good time to get out too.
This is an illustration of how you might have exited on this parabolic move.
Use an Indicator
As I mentioned in the beginning, indicators can be a great way to identify the end of a trend. There are a ton of indicators out there, but I'll show you 2 popular ones.
The first one is a series of moving averages. You can enter on a bounce off the longest moving average and exit on a close on the other side of the shortest moving average.
In this example, you would exit this downtrend when price closes above the shortest moving average, which is the 20 EMA.
Another indicator that you can use to exit a trend is the Parabolic SAR (PSAR). Many traders trail their stop loss by 2 or more PSAR levels.
That gives price some room to wiggle around so you don't get stopped out easily. Here's the same trend above, but with a PSAR indicator.
You can compare the differences and see which one you like best.
Elliot Wave Theory
In my opinion, Elliot Wave analysis doesn't work well as a primary trading method.
Some traders would disagree.
I feel that some traders put too much faith in the wave count and try to analyze every single move through that lens. Where each wave begins and ends can be quite arbitrary, so it's not a reliable way to trade.
However, I do consider it a very useful way to estimate when a strong trend could come to an end. If you know that the trend could end on the next push, then you'll be prepared to take your profits off the table.
So I would encourage you to count waves in a strong trend.
Elliot Wave Theory proposes that every major move has a a series of 5 waves. There are alternating impulsive and corrective waves.
The numbers mark the end of each wave.
If you want to learn how to count Elliot Waves, this is a good place to start.
You can also read the best book on the topic by Frost and Prechter, which can be found here.
Price Action Trend Reversal Patterns
There are several price action chart patterns that you can use to potentially predict the end of a trend.
Here are the ones that are easy to spot and can be found in most trading books.
Double Top / Bottom
This is an easy pattern to spot. You're looking for price to hit a level twice and there is usually a sharp move between the 2 pushes.
This is a good example on the AT&T chart. A long downtrend ended with 2 touches of a support level (orange line).
If you were short this stock and stayed in after the double bottom, then you would have given back a lot of profits on the retracement after the double bottom.
The Batman Chart Pattern
This pattern is a variation of the double top/bottom. It's a slight difference worth mentioning because this pattern is a little more reliable, in my opinion.
There is a double touch of a level, but instead of 2 successive touches, there is a very noticeable consolidation area in the middle of the 2 touches.
Here's what it looks like when it happens at the end of a trend.
The second touch is usually lower than the first touch at a top, and higher than the first touch at a bottom.
To get more details on this chart pattern, watch this video.
Head and Shoulders
A head and shoulders formation can be thought of as a triple top or bottom. Price tries to break through a level 3 times, then fails.
What makes this pattern easy to spot is the fact that the first and third pushes are not as strong as the second push.
So it looks like the outline of a person with the head in the middle and the shoulders on either side.
This CADJPY chart shows a good example of a head and shoulders top. The shoulders are marked with the blue arrows.
Here's and example of a head and shoulders bottom at the end of a downtrend.
Rounded Top / Bottom
A rounded price structure is like a large ship turning around.
It's gradual, has a wide arc and takes some time to complete.
But once you see this type of move starting to happen, it can be a great clue for you to exit your trend trade.
Here's an example in gold.
In order to see this pattern, you have to zoom out a little and look at the bigger picture. There are no specific characteristics here, like the patterns that I previously mentioned.
It's just a rounded formation that can have a few spikes and looks a little disorganized.
But if you can identify it as a rounded top or bottom, it can help you get out before you lose a lot of your gains. You might even be able to open a trade in the opposite direction.
Extremes in Trader Sentiment
This is a method that isn't talked about often, but it can be a great way to figure out what professional traders are doing.
The common stat floating around the internet says that about 90% of aspiring traders fail to become consistently profitable.
That might not seem like useful information, until you realize that if you can trade in the opposite direction of the average retail trader, you'll have a very high probability of making money.
There are a couple of statistics that capture positions of both retail traders and professional traders.
The Commitments of Traders Reports
A commonly used metric is in the futures markets is called the Commitments of Traders Report (COT). It tracks the open interest positions of commercial and non-commercial traders.
Here's a description of the report from the CFTC website:
“These reports have a futures only report and a combined futures and options report. Legacy reports break down the reportable open interest positions into two classifications: non-commercial and commercial traders.”
So when the commercial (larger) traders are mostly on one side of the market and the non-commercial (smaller) traders are mostly on the other side, that can be a good time to do what the commercial traders are doing.
Retail Forex Trader Positions
Another trader sentiment indicator was created by my friend Walter Peters. As he has mentioned a couple of times on our Think Profit Podcast, he knows people who started a hedge fund based on trading in the opposite direction of losing traders.
The fund was very successful, but the hardest part was getting traders to continue trading because they would lose money and give up.
Based on this information, he created an indicator that aggregates the net positions of retail traders across several different Forex brokers. When the retail trader sentiment goes in one direction, he looks for low-risk chart patterns that will allow him to enter a trade in the opposite direction.
For example, 83% of retail traders are currently short the GBPNZD currency pair. So it might be worthwhile to look for a long trade.
But it depends on what the chart looks like…
The current chart is in a strong uptrend. So it might be worth looking for a long trade on the next pullback.
Like anything else, don't start trading this method without testing it. Track it over a few months and take a few demo trades.
The bottom line is to look for opportunities to either trade with the big traders, or trade against retail traders.
When either of those groups have a lot of positions on one side of the market, that give you a clue of what may happen next.
Another way to figure out when a trend could be coming to an end is to look at the momentum of the price action.
At the beginning of a trend, there are strong moves with big candles. As a trend matures, the candles get smaller and the pushes have less drive.
Here's an example of momentum slowing at the end of a trend. Notice how price starts off strong, but then ranges, then eventually fails.
You can also use a trailing stop EA to get you out of a trade. When price momentum starts to slow down, the trailing stop loss will “catch up” to price and close the trade before price reverses too much.
We have a MetaTrader 4 EA that trails the stop loss on a trade by risk multiple.
There are also other methods like using a 3-bar trailing exit.
Here's the video that demonstrates the concepts mentioned above. Be sure to watch the entire video to learn all of the methods.
Final Thoughts on Spotting the End of a Trend
The big money is made by holding your trades when there is a strong trend.
Nobody knows exactly when a trend will end, but using one or more of these techniques can help you ride every trend for as long as possible.
Like all other trading methods, you need to practice and test, in order to use them profitably.
Get started by identifying the strategies that make the most sense to you. Then backtest each strategy and find out how well it works in the markets you trade.