Knowing when the end of a trend has arrived is as imperative as knowing when a trend is about to start. The old adage of buy low, sell high creates the beautifully simple idea that every trader dreams of in finding an indicator which will tell us precisely when a trend will start and finish. Trading would be made far more pleasant and enjoyable if this was possible and 100% accurate. As we know, trading is not that simple, and, even though we have several indicators available which can offer us an idea of the potential for a reversal, they do not offer a clear-cut or definitive entry or exit.
Without being perfect, these indicators can be helpful in raising a traders awareness of the possibility of reversal and prevent us from jumping onto a trend which is running out of steam. One such indicator is the MACD histogram. This indicator plots the swing highs and swing lows in terms of their strength, usually synchronised with a swing higher in price represented by a higher movement on the histogram. The beauty of this indicator, however, is not in its ability to show us what is already happening but as a way to measure the strength of the current trend. The concept of divergence is incredibly useful in trading with this indicator. This literally means the ability to be able to identify when the price is reaching a higher high than the previous high but the indicator is not. The two are no longer synchronised and this is a very useful early warning that the power of the current trend may be waning. The more obvious the divergence, the more likely that price will require at least a correction before moving back in the direction of the trend.
Alongside divergence in the MACD, the Average Directional Index (ADX) and volume indicators can combine to show us when a trend may be coming to an end. The ADX is a good indicator for showing the strength and direction of a trend. If a trend is considered to be weakening the ADX will fall below 20 and, with a crossover of the supplementary plus and minus indicators, this can be a very good indication that it may be time to take profits and avoid entering into the trend. Used in conjunction with a volume indicator measuring the level of market participation in a trending market it can be a good gauge to finding out when interest in maintaining the trend is decreasing. A common occurrence at the very end of a trend is an abnormal increase in volume and a price movement in the direction of the trend. In many cases, this will also pre-empt the end of the trend as traders try desperately to maintain the momentum.
There are several other good indicators which can be used to supplement each other in establishing when a trend is running out of steam. Included in these are oscillators which will show us when a currency is considered to be overbought or oversold. Due to the number of traders watching this indicator it becomes something of a self-fulfilling prophecy and price eventually will reverse from these extreme positions. The key to using any indicator to determine the end of a trend is to use a supplementary indicator to reaffirm the signals. If two or three indicators agree with each other the chances are that the trend will be very close to its end.
Michel Kalib is an online forex trader and a mentor. He has been working for more than 8 years in the Forex industry.