Retracements

Written by Miroslav Marinov

Miroslav Marinov

Miroslav Marinov, a financial news editor at TradingPedia, is engaged with observing and reporting on the tendencies in the Foreign Exchange Market, as currently his focus is set on the major currencies of eight developed nations worldwide.

, | Updated: October 30, 2024

As we already said, a trend rarely follows a straight line without including a series of smaller trends. These smaller countertrends are known as retracements.

Definition

A retracement represents a temporary reversal in the direction of prices, which goes against the major trend. It is also called a correction to the principal trend. Retracements and reversals should be distinguished. Retracements are usually short-term changes within the major longer-term trend, while reversals signal the end of the larger trend and the beginning of a new trend.

During a significant uptrend the rise in prices is interrupted periodically by downward corrections. The beginning of these corrections is usually a resistance point, while the bottom is usually a support point. A retracement is a smaller trend itself and runs in the opposite direction to the major trend.

On the 4-hour graph of USD/CAD above we can see a large (major) uptrend with a number of small countertrends.

Retracements can be very informative

Within a trend, many retracements of different magnitudes and time periods can occur. As the end of a correction is marked by the support or resistance point (depending on the trend direction) for the longer-term trend, the length and time of this correction can reveal us something concerning the longer trend.

In a sharp uptrend we can expect that retracements may be short and may not retrace a huge percentage of the prior climb. A general rule is that if a trend appears to be rising strongly, then retracements may be less than 50% of the previous uptrend. This is also valid for downtrends.

In case the retracement in an uptrend extend its decrease to more than 50%, then the trend line in the longer uptrend would become irrelevant. Therefore, the amount of a retracement provides an indication of what the strength of the larger trend is.

A retracement occurring in a still existing trend can provide a trader, who missed the earlier stages of the trend, with the opportunity to ride the longer trend. In case the retracement continues to hold above the longer-term trend line and continues not to retrace more than 50%, this situation is an opportunity for a trader to act in the direction of the longer-term trend.

Exact percentage?

In reality retracements rarely reach a specific percentage. There are analysts, however, who believe that retracements measured in percentages can provide a good point to enter into a trade. In an uptrend or downtrend prices tend to retrace a specific percentage. Those mentioned the most are 33 1/3%, 50%, 66 2/3% and the famous Fibonacci percentages – 38.2% and 61.8%. We shall discuss the so called Fibonacci retracements at a later time.