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Written by and copyright © 2005-2013 by Thomas N. Bulkowski. All rights reserved.
In my book,
Trading Classic Chart Patterns 
(pictured on the left) on pages 22 to 24 (down trendlines) and 42 to 45 (up trendlines), I discuss a technique for detecting trend changes which I call the 1-2-3 trend change method. I did not invent
the method, rather, Victor Sperandeo did. His book,
Trader Vic: Methods of a Wall Street Master 
(pictured on the right) discusses the technique.
Not only does his method provide a consistent way to draw trendlines, but it helps determine when the trend has made a meaningful
change in direction. Discovering when the trend changes and taking advantage of it is what trading is all about.
Alas, the method is not without flaw. You can use it on any time frame, but how much information you display on a chart may determine which trendline to draw, and that can dramatically
change the trading landscape. Nevertheless, in tests I found that the method helps detect a trend change, so it adds value. Read my Trading Classic Chart Patterns book and the following
for more information.
1-2-3 Trend Change For Downtrends
Select the timeframe for which you are interested in determining when a trend change has occurred or will occur.
Draw a trendline from the highest high (Point C in the figure) to the lowest low
(A) on the chart such that price does not cross the trendline until after the lowest low (point 1), then follow these steps.
Step 1: Find where price closes above the down-sloping
trendline. This is shown in the chart as point 1 and a trendline pierce is
the first indication of a trend change.
Step 2: Price tests a recent low. The recent low is
at point A and the test is at point 2. Point 2 can be
below
point A but it must be clear that price is moving up,
not continuing down.
Step 3: Price closes above a recent high. I show
the high as point B and price completes the 1-2-3
trend change
method when it rises above B at point 3. The high
(point B) should be between
points A and 2.
In a study I conducted of
this method, 73% (74 of 101 samples) of the time price climbed at least 20% from
the low, confirming a trend change.
1-2-3 Trend Change Downtrend Example
The chart on the right shows an example of the trend change method applied to downward price trends. Point A is the highest
high on the chart (on the left half, that is), point B is the lowest low. The trendline connecting the two does not cross prices until after point
B. Point 1 is the trendline break. Point 2 is the retest and 3
is a close above the high between points 1 and 2. Point 3
is where price changes trend.
1-2-3 Trend Change For Uptrends
The steps for upward price
trends are similar to downward ones. Refer to the chart to the left.
Start by drawing a trendline from the lowest low (point C) to the highest high
(A) on the chart such that price does not cross the trendline until after the highest high
(point 1). Then follow these steps.
Step 1: Find where price closes below an up-sloping
trendline. This appears in the chart as point 1 and a trendline pierce is
the first indication of a trend change.
Step 2: Price tests a recent high. The recent high
is at point A and the
test is at point 2. Point 2 can be above
point A by a little but it must be clear that price is
moving down, not continuing up and making new highs.
Step 3: Price closes below a recent low. I show the
low as point B and
price completes the 1-2-3 trend change
method when it closes below B at point 3. The low (B) should be between peaks
A and
2.
In a study of 67 samples,
I found that 29 or 43% showed declines of at least 20%, representing a trend change.
1-2-3 Trend Change Uptrend Example
The chart on the right shows an example of the trend change method applied to upward price trends. Point B is the highest
high on the chart, point A is the lowest low. The trendline connecting the two does not cross prices until after the highest high, point
B. Point 1 is the trendline break. Point 2 is the retest, and 3 is a
close below the lowest low between points 1 and 2. Point 3 is where price
changes trend.
-- Thomas Bulkowski
Copyright © 2005-2013 by Thomas N. Bulkowski. All rights reserved. Lead me not into temptation. I can find it myself.
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