We mustn’t confuse a retracement with a reversal. Retracements are temporary changes in the trajectory of an overarching trend. A retracement occurs against the predominant trend; however, the trend will be reinstituted thereafter. A long-term uptrend will see numerous bearish retracements throughout its continuance. Conversely, a long-term downtrend will see numerous bullish retracements throughout its continuance. Many traders use the terms “pullback” and “retracement” interchangeably. However, we should keep the two distinct. A pullback is a transient move against the predominant trend that does not mean the percentage price move requirement to be characterized as a retracement. Retracements generally move between 33-66% against the predominant trend.
We know how to distinguish a long-term uptrend now. We analyze progressively higher peaks and progressively higher troughs. In the previous examples, I am certain you noticed how price movement would trade against the predominant trend for transient periods. These price moves are considered retracements. There is a myriad of catalysts that may initiate a retracement. More often than not, retracements are the result of natural supply/demand dynamics. For now, let’s think of bearish retracements during an uptrend as a transient period in which selling pressure overpowered buying pressure. Bullish retracements during a downtrend reflect a transient period in which buying pressure overpowered selling pressure.
Remember, retracements always precede the continuation of the predominant trend. For example, let’s say an uptrend is in operation. Prices reach a peak and subsequently move against the predominant uptrend. A trough forms and buyers regain control of the market. The uptrend continues thereafter. This is a retracement. Now, let’s say prices continue uptrending and form another peak. Buying pressure exhausts and sellers take control of the market, similar to how a bearish retracement initiates. Prices decrease, but the buyers never regain control. Eventually, the uptrend is considered inoperative. This is not a retracement, but a reversal.
Figure 1.1 shows marked bearish retracement during a long-term uptrend spanning several years. Notice how the retracements are conspicuous. Each marked retracement precedes the continuation of the predominant uptrend. Let’s look at the chart once more and identify pullbacks, not retracements.
Figure 1.2 shows marked pullbacks during a long-term uptrend. Remember, many traders and analysts use the terms “pullback” and “ retracement” interchangeably. Pullbacks incorporate a small percentage price movement against the predominant trend. Retracements incorporate a larger percentage price movement against the predominant trend. If we were to analyze an intermediate-term trend, even smaller price movements against the intermediate-term trends would constitute a pullback. Let’s take a look at retracements and pullbacks during an intermediate-term trend.
Figure 1.3 shows the disparity between pullbacks and retracements during an intermediate-term downtrend. Notice how retracements are more conspicuous.
Figure I.12 shows the variance between a bearish retracement and a bearish reversal. A bearish reversal moves more than 66% against the trend preceding trend.
Figure I.13 shows the variance between a bearish retracement and a bullish reversal. Notice how each bullish retracement precedes the continuation of the predominant downtrend. However, the bullish reversal constitutes a change in the predominant trend; bearish to bullish.
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