Imagine this scenario. Price starts to rise. Keeps rising. Then it starts falling.
And falling some more. And then it starts going back up.
Have you ever been in this situation before?
It looks as though price action may be rallying and a buy trade is in order.
You’ve been hit by the “Smooth Retracement!”
Nobody likes to be hit by the “Smooth Retracement” but, sadly, it does happen.
In the above example, the forex trader failed to recognize the difference between a retracement and a reversal.
Instead of being patient and riding the overall downtrend, the trader believed that a reversal was in motion and set a long entry. Whoops, there goes his money!
Check out how Happy Pip got fooled by the “Smooth Retracement” in one of her AUD/USD trades.
In this lesson, you will learn the characteristics of retracements and reversals, how to recognize them, and how to protect yourself from false signals.
A retracement is defined as a temporary price movement against the established trend.
Another way to look at it is an area of price movement that moves against the trend but returns to continue the trend.
Easy enough? Let’s move on…
Reversals are defined as a change in the overall trend of price.
Using the same example as above, here’s how a reversal looks like.
When faced with a possible retracement or reversal, you have three options:
Because reversals can happen at any time, choosing the best option isn’t always easy.
This is why using trailing stop loss points can be a great risk management technique when trading with the trend.
You can employ it to protect your profits and make sure that you will always walk away with some pips in the event that a long-term reversal happens.