Traders often look for signals that indicate a potential shift in the market movement. The change of character (CHoCH) is one of the many crucial signals. Understanding CHoCH can enable traders to capitalise on the trend shift early on and improve their trading outcomes. In this article, we will delve into the concept of change of character, how to identify it and the best strategies for trading it effectively.
Understanding Change of Character (CHoCH) in Trading
In trading, a change of character (CHoCH) is a phenomenon that refers to a significant shift in the market movement that often signals a potential reversal of the trend direction. Traders often look for a change of character when monitoring an asset’s price trends. Once it is identified, they enter into an appropriate position to capitalise on the trend reversal.
Here is a hypothetical example that can help you better understand the concept of change of character in the context of trading.
Assume there is a stock, XYZ Ltd. It has been in a strong uptrend for weeks, making higher highs and higher lows. However, the stock could not convincingly move past a certain key resistance level. Since then, it has been making lower highs and lower lows. This indicates a change of character, where the price movement has shifted significantly towards the bearish side.
On the other hand, let us assume that XYZ Ltd. has been in a prolonged downtrend, constantly forming lower lows and lower highs. The stock’s price suddenly breaks above a recent lower high. Since then, the stock has been forming higher highs and higher lows. This represents a bullish change of character, where the direction of price movement has shifted to an uptrend.
By recognising such changes of character early on, traders can quickly adjust their positions or enter into new ones accordingly and capitalise on the reversals.
How to Identify a Change of Character When Trading?
Accurately identifying a change of character is crucial when trading to effectively capitalise on the potential trend reversal. Here is a step-by-step overview of how traders can spot a CHoCH on the price chart.
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Establish a Trend
The first step of the process is to define the current trend over a specific timeframe. By tracking the asset’s price movement, traders can easily establish whether the trend is bullish or bearish.
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Identify Key Support and Resistance Zones
Once the trend is established, the next step is to identify key support and resistance zones. A support level is a level below which an asset’s price may refuse to fall, whereas a resistance level is a level above which an asset’s price may refuse to rise. More often than not, trend reversals occur at or near these zones. Therefore, identifying and marking key support and resistance levels on the price chart can help traders easily spot a potential change of character.
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Look for a Break in the Price Movements
An asset in an uptrend will make higher highs and higher lows. Meanwhile, an asset in a downtrend will make lower lows and lower highers. That said, a break in this price movement often leads to a change of character and an eventual trend reversal.
For example, if an asset that makes higher highs and higher lows breaks the price momentum and starts making lower highs and lower lows, it is said to have gone through a change of character.
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Analyse the Volume
For a change of character to fully materialise, it must be accompanied by a spike in volume. If the asset’s trading volume rises after a break in the price movements, it often indicates strong momentum in the new direction.
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Monitor Candlestick Patterns
Once a potential change of character is identified, it is important to validate it before entering into a position. This is because possible shifts in market momentum may sometimes fail to materialise due to various external reasons. Entering into a trade without confirming a change of character could lead to losses.
Therefore, traders must obtain confirmation of the market direction shift by monitoring reversal candlestick patterns like engulfing candles, pin bars or doji near key support and resistance levels. This way, they can significantly reduce the chances of adverse trading outcomes.
How to Trade a Change of Character?
Once a change of character has been identified and confirmed, traders must implement a good strategy to maximise potential profits and minimise risks. Here is an overview of one such strategy that can be used to trade change of characters.
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Confirm the Change of Character
The first step of effectively trading a CHoCH is to wait for the market to fully change direction before entering a position. Although this can lead to slightly lower returns, it helps avoid false breakouts.
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Enter Immediately or on Price Retest
Aggressive traders often enter into a position as soon as they confirm a change of character. While this can help maximise profits, it is highly risky since there is always a chance of the market failing to reverse.
A better idea would be to wait for the price retest to happen before initiating a position. A price retest is a phenomenon that occurs when an asset that has broken through a support or resistance level briefly revisits that level before resuming its direction.
For example, if an asset breaks through its resistance level, the price will revisit the broken level briefly before rising further. Traders can enter at or near this broken resistance level to capitalise on the resulting uptrend.
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Use Additional Indicators
When trading a change of character, using technical indicators can help maximise profits. For example, moving average convergence divergence (MACD) can be used to identify the entry point, whereas Fibonacci retracement levels can be used to identify profit targets.
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Manage Risk
When trading a change of character, it is important to focus on minimising risk. Using risk management strategies like stop-loss orders and position sizing can help with lowering risk and enhancing returns. Additionally, if the market conditions seem volatile, traders must avoid overleveraging and stick to a lower risk-reward ratio of 1:2.
Conclusion
Change of character (CHoCH) is a powerful concept in trading that can help identify potential trend reversals. By identifying significant shifts in market momentum early, traders can improve trading outcomes by entering and exiting at the right time.
However, it is important to note that trading based on CHoCH alone is not advisable. The markets may sometimes provide false signals, which can lead to severe losses. Therefore, traders must combine change of character with other technical indicators and reversal candlestick patterns to enhance the effectiveness of their trades.
FAQs
What does a change of character in trading indicate?
A change of character (CHoCH) is a phenomenon that signals a major shift or a potential reversal in the trend. For example, a change of character occurs when a bullish market suddenly reverses its direction and becomes bearish.
Can a change of character occur in any timeframe?
Yes. Change of character occurs on all timeframes, both short and long. That said, CHoCH on higher timeframes often suggests stronger reversal signals.
How do I confirm a change of character when trading?
Certain technical indicators such as moving averages, relative strength index (RSI) and moving average convergence divergence (MACD) can help you confirm a change of character in a financial market.
Can a potential change of character be a false signal?
Yes. A potential change of character in a financial market can sometimes fail to materialise. Therefore, it is important to obtain additional confirmation and use technical indicators to filter out false signals before initiating a trade.
What is the difference between a change of character (CHoCH) and a break of structure (BOS)?
A break of structure (BOS) is a phenomenon that confirms trend continuation. Meanwhile, a change of character (CHoCH) is a phenomenon that signals a potential reversal in the trend.
