How To Spot When A Stock Is About To Begin A Downtrend

If you were able to know when a stock is about to begin a downtrend, wouldn't that be really good? You could have sold your stock earlier or you could have even shorted the stock. After observing the market for many years, I have come to learn that a stock does not crash without giving you some early warning signals. Read more so that you can take advantage of a stock that is about to go down.

I would like to say that this article is very closely related to How To Spot A Top In Stocks. The article will tell you when a stock is about to top. This article you are reading will tell you when the stock is about to start a new downtrend.

There are 4 Stages That Every Stock Will Make

Very briefly they are:

  • Stage 1 Basing
  • Stage 2 Uptrend
  • Stage 3 Topping
  • Stage 4 Downtrend

We will now learn how to spot stocks that are about to start a Stage 4 downtrend.

Dropping Below Moving Averages

Dropping below moving averages may be one of the most simple ways to spot a new downtrend in a stock. A stock that breaks below many moving averages tell us that a new trend in an opposite direction is about to begin.

To spot a new downtrend, I often use the 20 MA and the 50 MA. The shorter MA (20 MA) tells me the health of the stock in the short term while the longer MA (50 MA) tells me the health of the stock in the mid term.

  • Breaking below the 20 MA is a first red flag 
  • Breaking below the 20 MA and 50 MA is very bad for the stock

One thing to note is that breaking below the 20 MA and 50 MA works better with rounded tops rather than the sudden crash of V tops. That's because the MAs are very good trend followers but bad at sudden changes. So a rounded top gives the MAs time to let the stock go below it. A V top on the other hand does not give the MAs the time to catch up with it fast enough. Therefore, breaking trendlines are more useful to spot stocks making a V top.

how to know when a stock is about to begin a downtrend

Remember that this concept works in all time frames. You can use it in the weekly charts, daily charts, 60 min charts as well as for day trading in the 5 min charts. Every time a stock drops below its 20 MA and 50 MA no matter what time frame, it should give the trader a red flag that he or she should not ignore.

Moving Average Crossovers

Moving average crossovers are some of the best tools to help traders and investors spot the beginnings of a change in trend. A stock will always have a moving average crossover when it begins a new trend. If a stock is starting a new downtrend, the 20 MA will cross below the 50 MA. This is known as a bearish cross.

You can use whatever MAs that you want. But the combination of a faster MA and slower MA will be best. Play around with a few MA combinations and find one set that you find most comfortable to analyze stocks with.

Do note that moving average crossovers works best for stocks that have rounded top. This is because a rounded top allows the MAs to catch up with them. After all, the moving averages are lagging indicators which are good for trend following. 

Breaking An Uptrendline

Breaking an uptrendline is usually used to spot a market top or a top in stocks. However, they can also be used to help traders spot the beginnings of a downtrend. When a stock has been climbing up for a long time and then breaks its uptrendline, it is a sign to traders that they should start to expect a downtrend. It does not mean there will be a downtrend. It just tells us to expect a downtrend.

Breaking Support Or Horizontal Trendline

Sometimes a stock may have an uptrendline that is too steep. Other times, the stock may drift sideways for awhile before starting a new downtrend. When a stock breaks its uptrendline whether it is slanting at a 45 degrees angle or too steep, it tells the trader that the upward momentum is slowing down.

A stock that trades sideways after it breaks an uptrendline is just delaying the stage 4 downtrend that may hit it. So what we can do is draw a horizontal trendline as the stock trades sideways. The lows of the trading range is also known as support. So when the stock breaks the horizontal trendline, it is also breaking support and this is bearish for the stock. Many stocks often start a new downtrend when it breaks it horizontal trendline.

Conclusion

There are perhaps many other ways to spot the beginnings of a new downtrend. But if you study the above indications and warnings and really apply it to your stock, you will be able to spot most of the downtrends in your stocks. That will save you a lot of lost profits or it can even give you an opportunity to make money by shorting the stock.

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