13 mins read
Don't we all think trading will be much easier and more profitable if we just know the right time to enter a trade? One of the main trading strategies regarding this is the price action retracement entry.
Simply put, price action is the analysis of price patterns in financial markets to make fully informed trading decisions. This type of technical analysis of market prices is dependent on mathematical evaluations removing all the guesswork involved in trading.
Price action retracement, in its entirety, refers to a period when the price of a commodity, currency, index, or option retraces its movement in contrast to current market trends. Think of it as a chart repeating its former pattern movements for short periods. It can either be an upward or downward movement in the opposite direction.
You must understand some of these special chart patterns to avoid surprises when trading in financial markets. While newbie traders may be oblivious to the terms ‘price action retracement entry’, seasoned traders have, more often than not, taken advantage of this powerful market pattern and made huge profits.
Why Price Action Retracement Entry is Important
As mentioned, price action retracement is when a price follows its original chart pattern in reverse and returns to the same direction it was initially moving in. So, how is this trading technique useful to traders? Retracement provides a unique trading opportunity: Traders get to enter markets at very ideal prices compared to traditional entries. In addition to this, retracement entries are a much safer way of trading. They offer very high returns with not so much risk.
Other reasons why retracement trading is a good strategy include;
- Retracement entries allow for the convenient placement of a stop loss.
- Better profit returns
- The reward is higher than the risk
Retracement Entry in Trading
With the basic definition of price action retracement in mind, there are several ways you can apply the technique when trading. What you want is to get the most favorable entry price and a manageable amount of risk. In the best-case scenario, a trader will predict the pattern, open a position, and stick with it to the end while making staggering profits: But there’s more to it.
Let’s break down how you can incorporate price action retracement entries into your trading plan and strategies.
The first step will be to identify retracement lines and levels. How do you do this? Simple! Check for recent swing highs, lows, and market uptrends or downtrends. Retracement will mainly occur when market trends are favorable. During such a period, retracement lines will appear as horizontal lines on a chart, indicating support and resistance levels where price reversal could occur. The strategy here (after you identify the pointers mentioned above) is to take a long position when the market is poised to go up and to go short when the market trend is falling.
Types of Price Action Retracement Entry
Now that you know what price action retracement entry is, as an objective trader, you should also learn the different types of retracement entries and how they could earn you more profits. We have compiled a list of various types of retracement entries that will equip you with the necessary exposure for when you meet head-on with the said patterns on a chart. Let’s dive in.
1. 50% Area Retracements
50% are retracements are some of the most prevalent behaviors in chart patterns. Here, the price will retrace 50% of its original movement; for both long and short-term moves. This phenomenon is common during times when prices are headed for uncertain levels –all-time highs or lows for example. During this uncertainty, the prices may fall back in the direction of the initial pattern they had initially taken. When reading a chart, this type of price action retracement entry is noticeable through a 50% level advancement zone.
50% are retracements are popular in that they appear in almost every chart, making it a must-know for all traders. In the long run, 50% of area retracements are ideal for seasoned traders who know how to capture the moment.
2. Retracement to Average Price
This may be one of the easiest retracement entry types that you can easily remember as it is not as technical. Depending on your average price, you just have to be on the lookout for a retracement entry level. An easy way to do this is by choosing the moving average that you can find on your broker’s charts. For example, you can choose a 21-day moving average period to help you find patterns. You then watch closely for price action patterns to form before you get in on the market.
But how does this happen? Well, market prices tend to circle back to the average price now and then. There is a high probability type of retracement entry and can run for weeks if not months. You can work this out by placing an average against the chart pattern values.
3. Retracement Entry of a Signal Area
If you want to enter with a strong position, you probably should wait for a replacement entry of a signal area. The good thing is that this entry type is more effective than other entry types and you are likely to make profits. But what exactly is a retracement entry of a signal area?
With this entry-type strategy, you ought to find a 50% pin bar retrace. You can find this by checking longer-tailed pin bars, which often have price retracement of up to half the distance from the high point to the low point. This gives you the chance to enter the market at a favorable price just remember to set a stop-loss order to ensure you do not risk too many funds.
4. Retracement Entry to an Event Area
Another easy retracement entry strategy to remember when looking for a suitable entry point is the retracement entry to an event or prior signal area. It is possible to use this strategy since there are always retracement patterns in a market.
In any currency market, the prices of an asset class will always retrace back to a pre-determined event area forming a pin bar signal. The price will then create another pin bar signal before taking a bearish turn. A retracement entry to this event area can give you the perfect moment to enter and profit from trades.
The good thing with this entry type is that it is a great area to enter trades and works perfectly for long-term trades. Just be sure to remember that the price takes a bearish sell-off after forming the second pin bar.
5. Retracement Entries Without a Price Action Signal
Retracement entries without a price action signal may be difficult to spot for novice traders but not for beginners. For example, the price patterns for an asset may show that the price of a currency pair rises when there are few retracements and suddenly stops showing retracements.
The signals may not be obvious, but the price is likely to fall from a certain position, especially if it does not struggle to breach that point. This gives traders a high-risk high reward by making a blind trade without price action signals. It is also important to work with a stop loss when making this entry as it predisposes you to too much risk.
6. Retracement to Key Level
A quick way to find a suitable retracement entry point is by looking for a retrace to a key level with price action confluence. You should check for three price action signals in this entry-type strategy. The signals come about when there is constant price retracing, up and down, that forms at these levels.
So, how do we find the retracement entry point when it comes to this strategy? Simple, you can wait for the currency price to retrace up and down to the key level and watch out for a price action signal.
7. Retracement of a Single Candle
This is an emblem of price action retracement entry trading. The use of a single candlestick to determine retracement entries is a popular practice for experienced traders who can easily identify the trend with a glance. The mechanism behind this method is to observe when prices fluctuate along retracement areas. The instant these price patterns come in contact with the said candle, a reversal is more likely to happen. Therefore, the goal is to look for candlestick patterns along retracement levels, and once this is achieved; observe the price for a downtrend or uptrend, take your desired position, and make a profit.
Pros and Cons of Retracement Trading
As popular as it is, price action retracement entry has its fair share of merits and demerits. Ultimately the goal of a trader is to evaluate these ups and downs and determine whether price action retracement is the way to go.
Pros
If you have been keen, we have already mentioned a handful of pros of retracement trading. If you haven’t been as keen, worry less. We got you! Below are the pros of retracement entry trading.
- Highest Probability Entries – Owing to the nature of a retrace, the price is likely to move in the same direction as it was after a retracement occurs. This allows traders to enter the markets through this entry –a high probability entry since they can predict the next movement of the said price.
- Better Risk-Reward Ratio – Retracement trading is lucrative because it offers a higher risk-reward ratio. Why? Because a retrace will allow you to enter the market when the price movement is bound to move in your direction. This allows for better decision-making and implementation of laid-out trading strategies.
- Better Stop-Loss Placement – With price action retracement entries as a trading strategy, guessing in the financial markets is out of the question. This translates to a better trading experience where you can efficiently place stop-loss orders without impeding the results of otherwise profitable trades. Retracement allows for placing stops at convenient areas on the chart, away from key levels or average points. The last thing you want is to place a stop loss in the wrong spot.
Cons
Price action retracement entry is an effective trading strategy. However, while we explore the pros involved in integrating retracement into your trading plan, let’s also take a look at the cons
- Missing out on good trades: Retracement trading requires substantial patience from traders. When waiting for a retracement pattern to appear, you could be missing out on other profitable trades. A trader may end up foregoing several trades while waiting for retraces which, in the end, can fail to happen. Now, while you can still opt to close in on these trades: You also risk opening too many counterproductive positions.
- Retracement entry generally results in fewer trades. We know that retraces occur in patterns, and monitoring the markets to capitalize on these patterns can take up the majority of your trading time. When you are up and about analyzing charts; sourcing for the perfect time to invest, other could-be profitable trades are eluding you. Retracement traders have fewer chances of carrying out more trades than other traders.
- Not suitable for some trading strategies– While using price action retracement entry types works well for long-term investors, it may not be the best strategy for day traders or scalpers. One needs to take a lot of time to watch the market for entry points and this may be unsuitable for those who want to make several trades a day.
Remember, these are only the risks: You shouldn’t be deterred from retracement trading as the pros outweigh the cons.
How to Test for Retracement Patterns
Retracement patterns are unique but can sometimes be mistaken for different technical analysis methods. Such a method is reversal. Reversal is when a price changes direction and moves along it for an extended period –longer than the amount of time it takes for a retracement to go back to market trends. While trading, price fluctuation can be a result of either one of the two trends.
For effective trading, you want to be able to tell the difference between the two. There is no exact way you can do this; however, you can analyze possible levels/areas where a retracement may occur. The first step is to know the difference between a retracement and a reversal, and then you can understand how they complement each other.
The next step will be the use of technical indicators. They include;
- Trend Lines
Traders use trend lines to identify retracement patterns easily. You can either input the lines manually (draw an upper line connected by high points and vice versa for a lower trend line) or use the trend lines indicator, automatically highlighting important price levels on the chart. After your trend lines are set, all that is left is to observe the price movement patterns.
A breach in the upper trend line, when prices start moving opposite to market trends, means a downtrend reversal is happening, and when the same happens for the lower trend line, an upward trend is in order. You should, however, note that a breach of either of the lines does not entirely mean that the trend stops there. It is advisable to use other technical indicator tools to remove all doubt.
- Moving Averages
A common technique deployed by traders, moving averages can be used to accurately test retracement patterns. As the name suggests, a trader will place a moving average price of a commodity/asset/option at set areas on the chart for a given period, and observe when price levels reach this point.
There are two classifications of moving averages: Exponential Moving averages (EMA) and Simple Moving averages (SMA). Each type of moving average has its applications and is dependent on the amount of data being processed. SMAs calculate recent price averages whereas EMAs cover average prices for a relatively long period.
Pro-tip – Be careful not to apply one too many moving averages on your chart as this may impede your trading strategies; in that, you might fail to pinpoint the exact area where a reversal is bound to occur.
Final thoughts: Price action retracement entry types you should know
This technique has long been used by seasoned traders, making it an effective trading concept. You will learn that when using retracement entries, you stand a better chance of making more profit in the financial markets. The good thing is that these trading strategies are not difficult to learn and any forex trader can utilize them and make profits. Be sure to also check out other trading strategies so that you can increase your trading knowledge and become a pro trader.
