In the world of trading, a term you’ll often hear is “retracement.” You might have heard many trading gurus on YouTube using the term retracement or pullback.
You can even find me using this terminology in my reel below (though I’m not any guru and just your buddy sharing my learnings with you).
View this post on Instagram
But what exactly does it mean? Let me break it down and simplify it for you.
What is Retracement in Trading?
A retracement is a small break or a pullback that a stock takes when it’s moving in an uptrend or a downtrend
Woh apne hindi mein ek qahawat hai na ki, “शेर लंबी चालांग लगाने से पहले दो कदम पीछे लेता है।”
(There is a saying in Hindi that “A tiger takes two steps back before making a long jump”).
That stepback, pullback, or pause is known as a retracement in trading.
Know about: What is Breakout Trading? How to Make Money with Breakout Trading?
Example of a Pullback or Retracement in Trading
Imagine you’re riding a bike, and when you hit a slope, you release the accelerator until the bike’s momentum slows down. That little pause is what we call retracement or pullback in trading.
Taking a small pullback helps the bike to pick up the speed again. The same happens when the stock or any instrument is moving upside or downside.
You can also think of it like shifting gears: just like the small pause when you switch from the 1st to 2nd gear, or from 2nd to 3rd. In trading, we call it a retracement.
Retracement or pullback can happen on both sides, the upside (after a rise) or the downside (after a fall).
Why Does Retracement Happen?
As I discussed in my swing trading article, a stock never moves up or down in a straight line.
It moves up or down making structures. It will move up, take a pullback, then move up, then take retracement, and so on.
It’s more like a series of waves, with ups and downs, and Higher highs and higher lows. This is how the market structure works.
So sometimes, after a big climb or fall, the stock needs to catch its breath before continuing its trend or momentum.
This is why retracements or pullbacks happen. They’re important and a healthy sign.
Why is Retracement Important in Trading?
A retracement is important for traders because it helps them in making decisions. Think of it like using sign boards during a bike ride that makes sure that you’re moving in the right direction. Here’s why retracement matters:
(1) Decision Time (Buy or Sell?)
When a stock retraces, traders can decide whether it’s just taking a break or if it’s breaking the trend and changing direction (potential reversal). This gives a trader the time to decide whether to buy, sell, or hold onto a particular stock.
(2) Timing or Tracking
Traders use retracement to time their moves. If they see a retracement after a big upward ride, they might think it’s a good time to buy because the stock could probably again go up. And if they see a retracement after a big fall, they might sell because the stock could continue to fall.
(3) Confirmation
Retracement can confirm trends. If a stock is in an upward trend and experiences a retracement but then again continues upward direction, it confirms that the trend is still intact.
Similarly, if a stock is in a downward trend and experiences a pullback but then continues moving downward, this confirms the trend as well.
So, retracements are used for trend confirmations as well.
Fibonacci Retracement
This is a popular tool that uses Fibonacci ratios to identify potential retracement levels.
Traders use Fibonacci retracement levels to predict where a stock might retrace before continuing its trend.
A Fibonacci retracement or Fibonacci trading strategy is very widely used by traders, which I will talk about in my next article or a detailed e-book.
The above book is one of the best books you can read to learn about retracements and all about Fibonacci retracements and Fibonacci trading strategies.
Bottom Line
When a stock is on the rise, retracement occurs when it takes a temporary pause or pullback before potentially continuing its upward momentum.
It’s like catching its breath before continuing the climb. Traders often look for these retracements as potential opportunities to enter the stock at a better price before the stock resumes its upward trend.
For a visual representation, again look at the reel that I’ve uploaded on the top.
There you can see that the stock is moving in an uptrend, then again 1-2 small red candles come before the stock continues to move upside further. That is known as the retracement or a pullback.
FREE Guide to Stock Market and Trading for Beginners!
Sharing is Caring. SHARE if you care!