Last week in part one, we looked at what a pivot is, some different types (or strengths) of pivots, and what makes a trend. We promised to follow up this week by showing how a trend ends, and how we can transition from one trend to another.

This is really straight forward, yet most seem to be very confused by these concepts. So let us begin by setting up a few rules to live by:

1. There are three possible trends; up, down, sideways.

2. On any chart, on any one timeframe, a stock can only be in one trend; they never overlap.

3. Charts can be absent of any trend (directionless, trendless).

4. We require ‘two’ consistent occurrences to officially be in a trend, for example; two higher highs, two higher lows for an uptrend.

5. After ‘one’ occurrence, aggressive traders may ‘presume’ a new trend and actually ‘play’ the second occurrence, even though the trend is not in place until the second occurrence has happened.

Simple? Let us look at some examples. Refer to last week’s lesson if the concept of a ‘trend’ is unfamiliar to you. These first two examples are very simple. In both cases, an uptrend exists, but something happens to it. By the way, for educational purposes we are discussing ‘uptrends’, but all of these comments apply equally as well to downtrends.

In the top picture, our uptrend with higher highs (HHs) and higher lows (HLs) fails to make a higher high at ‘1’. It makes an ‘equal’ high. This is just meant to be ‘approximately ‘equal’. We do not need to be exact. It failed to make a significant new high. This has now ‘challenged’ the uptrend. We know something is changing. The trend is technically still up, but we would hesitate to play it.

The lower picture has ‘broken’ the uptrend. On the last pullback we made a lower low (LL) for the first time. This ends the uptrend. Note however, that does not mean that we are in a downtrend (we do not have two lower lows and two lower highs), and we are not in a sideways trend (we do not have two equal lows and two equal highs). We are ‘trendless’, waiting to see what the next trend will be.

Let us now take a look at what happens next. The answer is obvious. Once the uptrend is broken, one of four things could happen. We could begin a downtrend, we could begin a sideways trend, we could resume the old uptrend, or we could stay ‘trendless’ waiting for one of the others to form. Here are a couple of possibilities and their potential action points. Below is a continuation of a likely pattern from the top picture, above.

We said that once a pivot forms at ‘1’, the uptrend has been ‘challenged’ because we could not make a higher high. Once we have a pullback that fails to make a higher low at ‘2’, the uptrend is now officially over. As ‘2’ becomes a pivot, we also have a ‘presumed’ sideways trend. Aggressive traders could look to play this sideways pattern with the VCM buy set up at ‘2’, but it is aggressive because it is not a sideways trend until ‘2’ becomes a pivot, and ‘2’ does not become a pivot until after you enter the play (remember, the pivot requires the bar to close, the entry to the buy set up does not). Once we get to ‘3’, we are already in a sideways trend, so shorting ‘3’ with a VCM sell set up is ‘standard procedure’. The same is true with the buy set up at ‘4’. We have now transitioned from an uptrend to a sideways trend. Now take a look at the bottom half of the first chart, the ‘uptrend broken’. Below is a likely continuation of that pattern.

The first diagram left off at ‘1’ as we had just made the first lower low. This breaks the uptrend, and we are trendless. Note that even after ‘2’ becomes a pivot, we only have one lower low (1) and one lower high (2), so shorting ‘2’ is beyond aggressive, it is just guessing. We can say once the pivot forms at ‘2’ we have a presumed downtrend, but playing that before ‘2’ even forms is too aggressive. However, as ‘3’ makes a lower low, the rally to ‘4’ can be shorted with a VCM sell set up by aggressive traders, because this ‘will be’ the second lower high, and we already have two lower lows. Once the pivot forms, we are officially in a downtrend.

Naturally, these transitions can happen in any way and in any combination. It is only by understanding pivots and trends that you can ‘read’ what is happening to that particular pattern. Note also, that on real charts we also use moving averages to help determine the best trends.