4. Pullbacks & Retracements

Understanding how the trend really works is a great asset for every trader. Unfortunately, trends do not last forever… Eventually it will make a pause or even stop and turn around (reverse).

It is important to realize when a reversal could occur because you want to avoid trading with the trend at its end.

Price movement is showing the path of least resistance. The path is decided by 2 main factors: energy and resistance. Or in other words, there is a continuous battle between momentum (energy) and support and resistance (S&R).

Sometimes momentum is stronger than S&R. In other cases momentum is weaker than S&R.

  • If momentum wins, then price will either continue its path with perhaps only a small interruption. The faster price is moving without showing divergence, the stronger the momentum will act.
  • If S&R wins, then price will stop at S&R and revert into the other direction or go sideways. Generally speaking, the more confluence a support or resistance level has, the stronger the zone will behave.

Retracements: how far can we expect price to go?

The trend typically stops at a point when momentum becomes weaker and in an area where support and resistance (S&R) shows strong confluence. This is when the retracement or reversal often starts and price develops a motion against the direction of the trend.

The next main question is: will price only make a light pullback, a deep retracement or actually reverse in its entirety?

Divergence is an important factor in answering this question. When multiple time frames are all showing divergence, then a reversal becomes more likely. The more time frames, the more likely that a reversal is about to start. For instance, divergence on the weekly, daily and 4 hour chart would seriously endanger the chance of trend continuation and increase the chance of a trend reversal.

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