For today Forex FAQ, I will go through with you this specific question from one of our fellow traders. This is a question that is often asked by new trader and it is also one of the questions that is in my mind when I first started trading a few years back. So let us spend a few minutes to go through this question and get it out of your mind.
Can you explain me the difference of retracement and reversal?
Basically most of us know that the forex market is always moving in waves and even though the currency is in a strong down trend, it never moves down with a single candle. The downward movement is always in the form of waves.
Indeed it can quite hard to really conclude that you are seeing a reversal or retracement. I do not know of any standard way of telling a reversal or retracement but what I am showing you below is simply my own way of telling a retracement or reversal and it does not represent what other traders use.
1) Forex Fibonacci Levels
I will usually make use of the Fibonacci retracement levels to differentiate the two. If the market retraces more than the Fibonacci 0.382 level, it is a reversal for me and if the market retraces less than the Fibonacci 0.382 level, it is simply a retracement.
However this method is a bit too lagging and you will not be able to take part in profiting from the reversal.
Other than the Fibonacci levels, I will also make use of the patterns that are formed by the candlesticks to tell reversal. I usually make use of the following candlestick patterns to tell reversal
- Head and Shoulder
- 1-2-3 Pattern
These are the 3 most common and effective reversal candlestick patterns that I often use in my trading. If they are being verified, it usually means a reversal is in progress.
3) Forex Trend Line
I will make use of the medium term trend line to tell whether the price is in retracement or reversal. Usually when the price breaks the medium trend line, it is on the way to reverse and you can then enter a trade to profit from it and take profit at the long term trend line.
However I am unable to tell you how to draw the medium and long term trend line as it is taught in my forex trend line book and this will not be fair to those who purchase it. If you have my book, you can make use of this method to tell reversal or retracement or if you did not purchase my book, it is okay as you can still make use of the other 2 methods to tell the reversal.
I hope that I have answered your questions and for those of you who have submitted your questions and have not been answered. Do give me sometime and thanks for your patient and understanding.
If you have anything to add to this post, do give your comment below or if you find this post useful for you and think that it will benefit other people that you know, you can help them retweeting this post.