Retracement is an important pillar of price action
The key to buy low sell high or sell high buy low is all about identifying retracement moves and entering at a good retracement level. It is such an important concept and is a key pillar of our Forex Tflow® Currency Trading course.
We have written quite a number of postings about retracements and recently an important phenomenon actually happened in the regional stock markets. I wrote about it here a story on Nikkei 225, Hang Seng Index and Straits Times Index meeting critical retracement levels.
The fact is price retracement is such an important market phenomenon/resource to master to make more money in the market.
4 simple rules to understand price retracement
Never mind about the Fibonacci levels. Today lets just talk about retracement only. I am going to use 3 simple pictures with some rules to demonstrate.
Imagine price moves from starting line X to Point 1 above. Imagine that we have established that X -> 1 is the trend i.e. up. When price comes down, any point that price stops in the green zone is retracement.
Rule #1 – Retracement is a counter-trend move.
Rule #2 – Price that retraces back to starting line but does not cross is still a retracement.
Retracement happens in the market because bulls who were long took profit at high. Bears who were selling counter-trend pushed price down. Retracement happens in the market all the time. Because it always happens, the best time for buyers is to buy during a retracement because price gets lower or cheaper.
Rule #3 – Price continues in direction of trend when retracement is over.
And hence the saying ‘buy low sell high’. A continuation will move in the direction of Point 1 and can extend beyond it.
What is no longer retracement?
What if price retraces beyond the starting line? Can price retracement tell me whether price trend has changed?
Rule #4 – Price retracement anywhere beyond the starting line starts a new trend.
Price retracing beyond the starting line is no longer retracement. It becomes a reversal. All the buyers between X -> 1 lost money while sellers were able to push price lower. The new trend is down and buying becomes counter-trend trade. The right thing to do now is to wait for price to retrace in order to sell high buy low.
More retracement tips for sophisticated traders
- Retracement usually returns price to fibonacci retracement levels.
- Traders should not attempt to ‘fish’ for price at retracement levels. The best move is to wait for price action to confirm that a fib level is valid before entering.
- Retracement back to X (100% retracement) can sometimes overshoot as part of stop-hunting, volatility and many other reasons. Traders must separate when it is overshooting and when it is a reversal like Rule #4.
- Retracement moves can become subtrend inside lower time frames. Over-inspecting multiple time frames can result in confusion but higher time frames are always more critical.
- With-the-trend trades that exploit price retracement to make price cheaper to buy is a smarter way to trade than to buy-higher-hoping-to-sell-higher type of breakout trade.
Director, TerraSeeds Market Technician Pte Ltd. Trader, investor. @sohtionghum was picked ‘Top 70 Forex Twitter in 2015’. Operates multiple strategies.
“Dear reader, I do not have a financial license to give advice. I do not know you the reader. Your financial objective and risk tolerance may be different from mine. I am not responsible for any consequence of your action.