Tuesday, November 18, 2008

Simple way to confirm a long term trend reversal

The term "trend reversal" is very common in technical analysis for share, index, commodity, derivative, or other kind of securities. Technical analysis has many kind of complicated signals to catch the "trend reversal" based on price movement, trade volume movement, and/or the combination of both.

However, technical analysis might be too difficult to master for layman like you and me. The "simple way" that I'm going to discuss here is indeed a very simple way. It is so simple that can be described in the sentence below:

"A trend reversal is very possible if a bottomed price doesn't drop beyond its bottom made, or a topped price is unable to produce another record high."

You might want to question that what's so special with the above sentence, every Tom, Dick and Harry also know about it.

But I notice many people doesn't know how to apply this simple and straightforward sentence to their investment strategy.

Believe me, it is really as simple as that, and its accuracy is no worse than using technical analysis. Especially when looking for long term trend, it is particularly effective.

To apply this simple saying to your investment strategy, you need to determine the nature of your target. You need to find out from its historical record that, does it has high volatility with drastic price movement (high beta), or does it pretty stable with low beta?

Then, add in the time factor into the sentence by determining a suitable time period. Your sentence should now sound like this:

"A trend reversal is very possible if a bottomed price doesn't drop beyond its bottom made after X number of days, or a topped price is unable to produce another record high after X number of days."

If the beta is high, apply a larger X factor, otherwise, you may apply a smaller X factor. Your X should not be too large that it takes too long until every Tom, Dick and Harry also know the trend has reversed, as you will lose the opportunity to buy/sell at a less risky position.

A good X value for common stock is 1 month, which you need to adjust based on the volatility of your target. Beware that X would be of not much meaning if it is higher than 3 months.

Let's take an example. ICAP (5108) made a bottom on 29-Oct-2008 at the price of 1.15. Let's say you give it a 2 months period for your observation. Therefore, if by 29-Dec-2008, the price of ICAP is still all the way staying above 1.15, and there is no short term tendency sign for it to fall back to 1.15, you can predict that 1.15 made on 29-Oct-2008 is its bottom, and you can start accumulating it at the price near to its bottom.

Of course, this is just a simple and stupid method, which is not bullet proof. But it is a good method, because by the time your simple "signal" triggered with this method, you will notice that almost all the technical analysis indicators are pointing to a bullish position, since technical analysis is meant to sense the trend in a much faster timeframe. So, technically speaking, you are quite unlikely to be wrong, unless market affected by unforeseen sudden factor.

Disclaimer: This article is intended for sharing of point of view only. It is not an advice or recommendation to buy or sell any of the mentioned stock counters. You should do your own homework before trading in Bursa Malaysia.


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