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With the XJO rebounding from support near 4500 and with resistance near 4900 is important to distinguish between a rally and a new uptrend. A sideways market calls for different trading methods.
It's useful to know the difference between a rally and a trend because this determines the best trading methods to use. The difference tells the trader if he should use short term trading methods or trade for a defined percentage return on the trade.
A rally may be part of an established uptrend. The rally lifts prices well above the long term uptrend line, but then prices retreat. The price retreat retests the uptrend line and uses it as a support.
These rallies offer short term trading opportunities. They are similar to a small bubble in the trend. This is shown in area 1 on chart 1. There is no change in the long term trend.
A rally appears in an uptrend environment after a market retreat. A long term uptrend has developed a retreat. A rally develops when the price changes direction and moves upwards. This is area 2 on chart 2.
The rally is a short term price movement continuing for 3 to 10 days. The rally often moves to a previous resistance level, and then retreats again. The rally is not a sustainable trend. In this situation the rally may be part of a longer term downtrend pattern. This confirms a change in the long term trend.
A rally may also develop in a downtrend. The rally follows a fast retreat, or price dip, in the downtrend. The rally quickly lifts the price upwards until they hit the long term downtrend line. Then the price retreats and continues to move down. This is area 3 on chart 3. There is no change in the long term trend.
A rally is a fast upwards price move that is in the opposite direction to the previous market retreat.
Sometimes a rally will develop into a trend. When a retreat and rally pattern has developed as part of an uptrend then the rally develops into a new uptrend when the price moves above the previous resistance level. This is area 4 on chart 4.
In this situation the rally turns into a new trend that may continue for several weeks or months. The rally becomes part of a continuation of the previous uptrend. This has the potential for a long term trend change.
When a downtrend changes to an uptrend the first development is usually a fast price rally. When the rally breaks out above the downtrend line there is the possibility of a new up trend developing. Usually the rally breakout is followed by a small retreat and then another rally.
The long term trend line is created when the pattern of rally and retreat behaviour has an upward bias. This is shown in area 5 on chart 5. Traders and investors look for this type of rally behaviour so they can join a developing long term uptrend.
The danger in the current market is the development of a broad sideways trading band. The upper edge of the band is a resistance level and the lower edge a support level. In this market condition traders see frequent rally and retreat behaviour as the market moves sideways.
This is shown in area 6 on chart 6.
These rallies offer very short term trading opportunities with limited profits. Traders use MACD, Stochastic and sensitive momentum indicators including the parabolic SAR to trade in this environment.
Many traders believe the market is developing a broad sideways movement with many short term rallies.
A rally is a short term uptrend in prices that usually develops a retreat when it hits a resistance level.
An up trend is a long term trend that continues for many weeks or months. Trends often start with rally behaviour so traders must be alert for the signals that show when a rally is developing into a trend.
Daryl Guppy, well-known international financial technical analysis expert. He is an equity and derivatives trader and author of books including Share Trading, Trend Trading and The 36 Strategies of The Chinese For Financial Traders. His weekly analysis newsletters are followed in Asia and Australia.
Information provided is in the nature of general comment only and neither purports nor intends to be, specific trading advice.