AUDUSD—Breather or beginning of a reversal?

One of the biggest challenges a technical trader faces is determining when a trend is changing. Reams have been written on how to detect this change. Often these attempts are unsuccessful. It’s easy to understand why this is true when there’s no clear understanding on why prices trend in the first place. Yes, there’s an interaction of supply and demand; yes, there’s a coming together of buyer and seller in the transaction, often for a variety of reasons. But the factors are many and not easily understood. If the cause isn’t understood it stands to reason that the solution—knowing when one trend is ending and a new one beginning—is not easily understood either.

This is why I ignore those who insist the end of a trend is near. For example, look at how many are saying the S&P is ready to reverse and have lost money shorting it in the last few months. It may be ready to reverse. But that doesn’t mean much for the trader who keeps shorting it and then watches as it continues up.

One hint of a possible trend reversal is when a pair breaks a major trend line. Gann wrote that a hint was when the asset broke old or new tops especially after having had a long run in any given direction. Divergence is another clue to a potential trend change. The challenge for us as traders is to be aware of these hints but to only act on the preponderance of evidence.

For AUDUSD the trend since March has been up. It has been a steady money maker for those who bought. It has also made money for those who have traded short term reactions. As usual, though, the real money in a strongly trending pair is made by going with the trend.

On the hourly chart below you see the long term daily uptrend line and the pair is far above it. (If by some chance it reaches that trend line it would be a buy, depending on what else is going on in the chart.) It broke an hourly uptrend line. There’s a hint, correct? There’s also negative divergence (non-confirmation of the trend) with RSI. Another hint. But non-confirmation is all over the place on the charts and while this is technically troubling, one shouldn’t be trading it by itself.

More significant to me is the rounding top that has formed. This indicates buying is slowing. That’s s-l-o-w-i-n-g, not stopping. It could be profit taking or it could be uncertainly. Regardless, it’s an observation.

For the last several hours it has been in an uptrend at the same time there is negative divergence on the RSI. But the pair has done this before recently. It dropped to a level it hasn’t been at since October 19th. So, given the overall uptrend with no signs it has been clearly broken and given that I could set a tight stop. I bought. I’ve moved my stop to breakeven.

Now we have to watch and see what the pair does next. If it comes to the rounding top I may look at it as a potential short because I can set a tight stop. Here’s the hourly chart:

© Dianne Fecteau, 2009. No part of this material may be reproduced in any form, or referred to in any other publication, without the express written permission of the author.

My purpose in writing this blog is to show you how one trader, me, makes trading decisions and survives while trading Forex. One of the biggest problems I had when I first started trading was trying to apply the “rules” to actual trades. Another was the psychology—limiting losses and letting profits run. If you study my blog you’ll see how I deal with both those issues. So my writings are not trade recommendations but rather educational in purpose. You have to decide on your own approach to trading. Remember that trading is risky.