By: Terry Allen
Another very popular Forex Strategy is Trend Retracements which has one major advantage, among others, that when using it you are actually trading with the trend. However, how can you determine whether a price is performing a retracement or undergoing a major reversal. This distinction is very important because you need to determine if a price decline is of a long term nature or just a mere relief dip.

For instance, many traders have experienced the frustrations caused when they have closed positions prematurely only to watch the market price then accelerate in their original chosen direction. To overcome this major drawback, you must know how to identify and trade retracements properly. So what exactly are retracements? They are temporary price reversals that occur within a larger price trend or channel. Their most important feature is that they do not last for any great length of time before the trend resumes its original direction.

As you are beginning to realise, you are well advised to know how to distinguish retracements from the more serious and permanent reversals. Their main differences are as follows:-

1. Retracements are usually caused by small traders taking profits and as such do not produce large increases in trading volume. Full reversals are normally driven by large institutional selling and generate significant increases in trading volume.

2. Retracements produce few serious chart patterns and the ones they do are mainly limited to a few minor candle patterns. Reversals, on the other hand, are very serious events and are capable of producing major chart formations such as double tops or head and shoulders etc.

3. The lifespan of retracements are usually very short and so not last normally for longer than a week or two at the most. Reversals are more permanent events and may last for weeks, if not, months.

4. Retracements are born normally after large price movements have occurred whilst reversals can occur at any time.

Why is it so important to distinguish between these two events? This is because traders always have to deal with difficult chooses whenever price retracements occur. For instance, should they hold their trade but risk a substantial loss should a full blown reversal become fully formed?

Alternatively, they could sell at the first signs of a price drop and then re-buy at a more favorable discount. However, they risk the chance of losing larger gains, by doing so, should the price suddenly surged back in its original direction.

Ready to start trading? Beginner traders may appreciate all that Plus500 has to offer, while intermediate or advanced traders will likely love the choice of trading platforms offered by Markets.com. Read our reviews of the top-rated Forex brokers such as our FXCM review or our AvaFX review to find the right broker for your needs.