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As soon as you have determined a method to help you detect a retracement, you will then need to devise a technique to enable you to determine its scope. The most popular tools for undertaking this task are:-
1. Fibonacci retracements.
2. Trendline support and resistance levels.
3. Support, resistance and pivot point levels
Fibonacci retracements are technical indications that attempt to predict the size of price corrections in a trending market. The most popular retracement levels used for the forex market are 38.2%, 50%, and 61.8%. In stronger trends, price usually retraces by a minimum of 38.2 percent whereas in weaker trends it can correct to 61.8%. The 50% Fibonacci level is the most widely monitored retracement level and is a common area to buy in up-trends or sell in down-trends.
Trends create price channels which have an upper boundary or upper trendline and a lower boundary or lower trendline. Retracements always bounce off these trendlines before the price resumes its original direction. A reversal, however, will break through a trendline. Professional traders use pivot points to identify important support and resistance levels. A pivot point and its associated supports and resistances are levels at which the direction of price movement can possibly change.
For example, breakout traders use pivot points to recognize key levels that need to be broken for a move to be classified as a real breakout. Despite all cautions, you must understand that a retracement can quickly convert into a full-blown reversal without warning. To protect yourself against serious loss, you must devise a sensible stop-loss strategy. To accomplish this, many traders place their stops just below the long-term trendline support if long and just above the long-term resistance trendline if short.
Once you have located methods to help you distinguish a retracement from a reversal as well determining its scope, you are then well place to deploy a trend retracement trading strategy. You could well use the breakout strategy to define the birth of a new price trends or channels. Afterwards, you can then use retracements to help you activate trade entries with good potential profits at minimum risk.
Once a trend drops to one of its trendlines, you should consider activating a trade entry. You could also set a protective stop on the other side of the trendline to protect yourself from a full reversal.
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