Trading Futures, the Emini S&P500;, It's All About Reversal And Retracement
For day trading, whether you are trading futures, the S&P500 Emini, currency trading, buying and selling crude oil prices or spot gold, the key to technical analysis trading is being able to identify when the trend has changed. If you can't recognize a Reversal from a Retracement, it is difficult to be profitable. This is true whether you are day trading or night trading.
What is a Reversal and what is a Retracement?
Investopedia defines a Reversal as "A change in the direction of a price trend. On a price chart, Reversals undergo a recognizable change in the price structure. An uptrend, which is a series of higher highs and higher lows, reverses into a downtrend by changing to a series of lower highs and lower lows. A downtrend, which is a series of lower highs and lower lows, reverses into an uptrend by changing to a series of higher highs and higher lows. "
What this means in layman terms is: Say you are trading the S&P500 Emini Future contract. The price has been steadily uptrending, going higher and higher. After a while, the uptrend peters out, the enthusiasm and momentum of uptrending is over. The S&P500 Emini starts going in the downtrend direction, where price begins going lower and lower. That is a Reversal.
What is a Retracement then?
Investopedia defines a Retracement as "A reversal in the movement of a stock's price, countering the prevailing trend. "
This definition seems clear as mud. It still says a reversal. Here's the difference. In a Retracement, the same S&P500 Emini is uptrending, going for higher highs in price. It is stair stepping its way higher...higher high, then higher high, then higher high. But between the higher highs, the price does what is known as a Pull Back. A Pull Back is generally short lived. If the price went up 5-6 ticks, it may drop 3 ticks, consolidate, and then press higher for another 5-6 ticks, repeating this movement over and over. Eventually, even the higher high will peter out and the Reversal will begin.
So the question becomes, how do we know that it is a Higher High / Retracement or that the trend has petered out and now we are starting a new trend, the true Reversal? That is an essential part of trading. Without that understanding and the ability to identify the difference between a Retracement and a Reversal, your trades are much more vulnerable, susceptible to whipsaws and stop out.
Say you are in an S&P500 Emini trade, the price is uptrending, you are making money. Then price begins to Pull Back. Do you exit your trade immediately or stay in the trade knowing that it is just a Pull Back and it will continue to go higher? Or what if you entered the Pull Back, trading short, thinking it was a full Reversal, and suddenly, within a couple of ticks, the price begins to go higher again.
You would quickly be stopped out. Here's another scenario. You saw the Pull Back, but did not enter because you thought the price would continue higher. Instead of entering short, assuming the price would go down, you entered long, expecting to see the price rise. But you were mistaken. It wasn't a Pull Back Retracement, it was a full Reversal, and suddenly you were stopped out.
The need to differentiate Retracement versus Reversal real time, while they are occurring, is essential to any trading success.
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