Assume the EUR/USD has been rising for some time now, and suddenly, it starts falling. That downward trend continues until it starts to climb back up.
Do you think that signals market reversal?
If you answer yes and start entering a long position, then you’ve become a victim of retracement. In trend retracement, the market temporarily moves against its primary trend but then returns and continues it.
You wouldn’t believe how many accounts had been wiped out due to failure to recognize trend reversal from trend retracement.
A trend retracement is defined as a temporary price movement against the established trend. Essentially, it’s called temporary reversal.
Another way to look at it is an area of price movement that moves against the trend but returns to continuing the trend. Basically, retracement are short-term periods of movement against a trend, followed by a return to the previous.
Once the retracement trend is over, the continuation of the primary trend is likely to happen.
The trend reversal is defined as the change of the overall market price movement.
When the EUR/USD has been treading upward, but then switches to downtrend and stays in that trend, a market reversal happens.
When the EUR/USD has been declining, but then it appreciates and continuously tread the trend, a market reversal also happens.
Retracement and reversals are far different from each other. However, most traders find it difficult to identify the two.
The worst case? When you mistakenly trade the retracement instead of the reversal, the market is crashing against you.
Instead of being patient and riding the overall downtrend, the trader believed that a reversal was in motion and set a long entry. When this happens, he literally just fed his money to the market.
| Retracement Trend | Reversal Trend |
| Usually happens after a significant directional movement | Can happen any time |
| Short-term movement | Long-term movement |
| No change in fundamentals | Change in fundamentals that drives up long-term reversal |
During the uptrend, there is buying interest, suggesting for the market to rally. During the downtrend, there is selling interest, making the market decline. | During the uptrend, low buying interest forces the price to decline. During the downtrend, low selling interest forces the price to increase |
To avoid being a victim of smooth retracement, here are the common indicators you can use to identify retracement trends.
The common way to identify market retracement is by using the Fibonacci Levels.
For the most part, price retracements hang around the 38.2%, 50.0% and 61.8% Fibonacci retracement levels before continuing the overall trend.
If the price goes beyond these levels, it may signal that a reversal is happening. Again, it may happen, not ‘it will happen’.
As you have already known, technical analysis isn’t an exact science where certainty matters more than probability. When you analyze the technicalities of the market, you simply speculate that the trend may happen based on the given historical data and prevailing trend.
In this case, the price took a breather and rested at the 61.8% Fibonacci retracement level before it resumed the primary trend.
After a while, it pulled back again and settled at the 50% retracement level before heading further its trend.
Another way to see if the price is staging a reversal is to use pivot points. This is a common and proven indicator used by technical traders.
When there’s an uptrend, you will look at the lower support points (S1, S2, S3) and simply wait for it to break. Meanwhile, in the downtrend, you look at the higher resistance points (R1, R2, R3) and again, wait for it to break.
The moment the trend is broken, a reversal is likely to happen.
The last method is to use the trend lines. When the major trend line is broken, a reversal can potentially happen.
By using this technical tool together with a candlestick chart price, you may be able to get a high probability of reversal and profit from it.