You’ve probably heard the word “retracement” or “retrace” quite frequently if you’re interested in trading the financial markets. But do you actually know what price retracements are, why they’re so important and how to properly take advantage of them? Perhaps not, but even if you do, today’s lesson is going to shed new light on how to utilize these extremely powerful market events… A retracement in a market is a pretty easy concept to define and understand. Simply put, it’s exactly what it sounds like: a period when price retraces back on a recent move, either up or down. Think about “retracing your steps”; going back the same way you came. It’s basically a reversal of a recent price move. Why are retracements important? For a number of reasons: They are opportunities to enter the market at a “better price”, they allow for optimal stop loss placement, improved risk reward and more. A retrace entry is more conservative than a “market entry” for example and is considered a “safer” entry type. Ultimately, the goal of a trader is obtain the best entry price and manage risk as good as possible whilst also increasing returns; the retracement entry is a tool that allows you to do all three of these things. This lesson will cover all aspects of trading retracements and will help you understand them better and put them to use to hopefully improve your overall trading performance. Now, let’s discuss some of the Pros and Cons of retracement trading before we look at some example charts… Pros of Retracement TradingLet’s talk about some of the many “Pros” of retracement trading. To be honest, retracement trading is basically how you trade like a sniper, which, if you’ve followed me for any length of time, you know is my preferred method of trading.
Cons of Retracement TradingOf course I’m going to be honest with you and let you know some of the “cons” of retracement trading, there are a few that you should be aware of. However, this doesn’t mean you shouldn’t try to learn retracement trading and add it to your trading “toolbox”, because the pros FAR outweigh the cons.
Retracements Provide Flexibility in Stop Loss PlacementsPlacing your stop loss at the wrong point can get you knocked out of a trade prematurely, that you otherwise were right on. By learning to wait for market pull backs or retracements, you will not only enter the market at a higher-probability point, but you’ll also be able to place your stop loss at a much safer point on the chart.
The Different Retrace Entry Types: ExamplesNext, let’s take a look at some of the different retrace entry types so that you can get a clear look at what they might look like…
In the example below, you can see price retraced or pulled back to the key horizontal level shown in the chart. There was no obvious price action signal here but we can see price quickly sold-off from that level after just barely pushing above it. This provided traders a very high potential risk reward scenario if they entered on a “blind entry” at the level with a tight stop loss…
Perhaps my favorite trading strategy of all time is the following example: Wait for price to retrace back up or down to an existing key level on the daily chart time frame, then watch for an obvious price action signal to form there. In my opinion, this is the highest-probability way to trade…
Markets have a tendency to retrace to the mean or average price, which you can see by putting a moving average on your charts. Shown below is the 21 day ema, a solid short-term moving average to see the trend on the daily chart. When price retraces back to this level you should watch closely for price action signals forming there to get a high-probability entry and get in on a trending market…
Price has a tendency to retrace approximately 50% of any major move and often times even short-term moves. This is a well-documented phenomenon and if you look at any chart you can see it happens, A LOT. Hence, we can watch for pull backs to these 50% areas as they will very often be formidable levels for price to move beyond, and as a result, price moves back in the direction of the initial move from that 50% level. It doesn’t happen EVERY time, but it happens often enough to make it a critical tool in your retracement trading tool box…
Yet another way we can utilize retracements is also very effective yet a little different than those we have discussed already. What we are looking at below is what I call a “50% pin bar retrace“. Often, on longer-tailed pin bars, you will see price retraces around half the distance from high to low of the signal bar, providing you the potential to enter at a better price and get a safer or tighter stop loss. Example 1: You can see below how a 4R profit was attainable by waiting for the retrace and entering near the pin’s 50% level. Example 2: You can see below how a 2R profit was attainable by waiting for the retrace and entering near the fakey patterns 50% area.
When price retraces back to what I call an “event area” it’s a very high-probability area to look for trades at. As you can see below, price retraces back to an existing event area where a pin bar signal formed and then forms another (bearish this time) pin bar before a huge sell-off takes place… ConclusionYou now have a solid introduction and (hopefully) understanding of what price action retracements are, why are they important and how to trade them. Whilst there is a bit more to it than what I discussed here, this lesson gives you a good foundation to build from and provides you with some tools you can start putting to work in your trading routine this week and into the future. If you want to learn more about retracement trading and get daily updates on any potential retracement trades, check out my professional trading course and follow my daily trade setups newsletter. This will both deepen your understanding of retracements and also help you apply these concepts to real-time price action signals then you can test and compare the outcomes between aggressive entries (like those in this article) and traditional entries that you’re probably more familiar with. Remember, I am always here to help you and share my knowledge with you, so keep learning and practicing. Please Leave A Comment Below With Your Thoughts On This Lesson… If You Have Any Questions, Please Contact Me Here. |
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