Reducing the quantity of unsuccessful trades and even setting you up with some winning trades can be accomplished by correctly differentiating between retracements and reversals.
It’s crucial to identify if a price change is a reversal or a retracement. It ranks right behind paying taxes.
Differentiating a short-term price shift retracement from a long-term trend reversal requires understanding a number of crucial characteristics.
| RETRACEMENTS | REVERSALS |
|---|---|
| Usually occurs after huge directional price movements. | Can occur at any time. |
| Short-term, short-lived reversal. | Long-term price movement |
| Fundamentals (i.e., the macroeconomic environment) do NOT change. | Fundamentals DO change, which is usually the catalyst for the long-term reversal. |
| In an uptrend, buying interest is present, making it likely for the price to rally. In a downtrend, selling interest is present, making it likely for the price to decline. | In an uptrend, there is very little buying interest forcing the price to fall lower. In a downtrend, there is very little selling interest forcing the price to rise further. |
Identifying Retracements Method #1: Fibonacci Retracement
Utilizing Fibonacci levels is a well-liked method of spotting retracements.
Before continuing the overall trend, price retracements typically linger near the 38.2%, 50.0%, and 61.8% Fibonacci retracement levels.
If the price rises above these levels, it can be an indication that the trend is about to reverse. Not will, as you may have noticed.
Technical analysis isn’t an exact science, as you may have realized by now, therefore nothing is definite, particularly in forex markets.
Before continuing the ascent in this instance, the price paused and rested at the 61.8% Fibonacci retracement level.
After some time, it started to go higher after pulling back once again and settling at the 50% retracement level.
Method #2: Pivot Points
Using pivot points is another approach to determine whether the price is preparing to reverse.
Traders will watch the lower support levels (S1, S2, S3) in an uptrend and wait for it to break.
Forex traders will watch the upper resistance levels (R1, R2, R3) in a downtrend and wait for it to break.
A reversal can occur if it is broken! Visit the Pivot Points lesson for more details or another review.
Method #3: Trend Lines
Utilizing trend lines is the final technique. If a significant trend line is broken, a reversal can be underway.
A forex trader may be able to obtain a high likelihood of a reversal by utilizing this technical tool along with the candlestick chart patterns previously explained.
These approaches can spot reversals, but they aren’t the only ones. Nothing can truly replace practice and experience, in the end.
You can discover a technique for identifying retracements and reversals in forex trading with enough practice.
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