Price Action: Late Trend Entries (Part 2)

Every uptrend or downtrend, when you look back after the reversal, you can identify that one "last trend bar." This is very important because institutional traders use line charts rather than bar charts. So in a bull trend, the highest closing price, and in a bear trend, the lowest closing price, become critical. At some point during the trend reversal, one bar or a group of bars will appear indicating that traders in the trend direction are giving up, while traders in the opposite direction begin to take control of the market. I call these bars "give-up bars."

If a very strong breakout occurs late in a bull trend, many traders will go short — trading against it — because this scenario is more likely the climactic end of the trend rather than the start of a stronger rally.

A tight trading range can also lead to a major trend reversal. After a bull trend, if the market enters a tight trading range, this means the market is in a "neutral" state. At this point, the probability of the trend resuming upward and reversing downward is approximately 50/50. Trend continuators have a slightly higher win rate, but with each additional bar entering the trading range, the probability gets closer to 50/50. If you see a small double top in a narrow trading range and the range has lasted more than 10 bars, traders will start considering whether a "lower high" major trend reversal might occur. This setup meets the following conditions: at least 10 bars within the trading range; at least 5 bars between the two tops; and the signal bar is a bear bar closing at its low, or with at most a one-tick lower shadow.

When the upward channel is very tight, the first pullback is usually a minor reversal. Bulls expect this is just a pullback that will ultimately form a bull flag, and the trend will continue upward, enough for them to exit at breakeven or with small gains and losses.

Bulls buy at the close of a bar, but then a disappointing bear bar appears, followed by several more bear bars. These bulls know they are at the top of the trading range but believe the upward momentum is strong enough that the probability of a breakout is reasonable. They also know that even if a decline occurs, this pullback will only be a bull flag and the market will bounce back to their entry price. However, the subsequent price action is disappointing. Many bulls place limit orders trying to exit at breakeven at their original entry price.

When you see two consecutive large bear bars breaking below what should have been a support level, this indicates the market is "Always In Short" and there is a high probability of continued decline, usually producing a measured move down.

Often traders do not pay attention to a very narrow trading range — some even call it "noise." But the market is always communicating information. If you pay enough attention, you can understand what the market is trying to say. Sometimes even a very small trading range can trigger a significant reversal. For example, a double top appearing in a narrow trading range, if it is a "lower high," could lead to a "lower high major trend reversal." Conversely, if a double bottom appears at the bottom of the trading range, it could also trigger a major bull trend. Just as a powerful breakout late in a strong bull trend is often the climactic end of the trend, if you see a very strong bear breakout late in a bear trend, it is usually also the climactic end of the trend rather than the start of a stronger bear leg. Every buy climax typically ends at a resistance level; every sell climax typically ends at a support level.

A climax does not mean the trend will immediately reverse. Most of the time, it just means bulls are exhausted. They start taking profits and then watch the next 5 to 10 bars to see what happens, attempting to resume the uptrend. But sometimes their strength is suppressed and the market reverses. An unusually strong rally late in a trend is more likely the climactic endpoint of the trend. The market may enter sideways action, with approximately a 40% probability of a climax reversal.

If these conditions are met, this is a reasonable swing short setup, targeting two legs down, with the stop loss above the signal bar's high. If bulls were still strong, the market could not behave this way. They are clearly unwilling to continue holding positions. Instead, they buy below bars and scalp. Bears sell at the prior bar's high and also scalp. The bulls' behavior has changed: they no longer buy at the close expecting a rally; they no longer look for swing buys but look for scalping opportunities. This indicates the market is no longer as strong as before. However, they will still try to buy above bars with stop orders, betting this is a bull flag that will break upward and continue. But ultimately, they will give up.