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The 3 Step Retracement Strategy

The 3 Step Retracement Strategy

2014-01-31 04:00:00
Walker England, Forex Trading Instructor
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Talking Points:

  • Retracements are pullbacks within a trend.
  • Find the trend and resistance using trendlines.
  • Entries can be planned using a Fibonacci retracement.

When it comes to trending markets, traders may consider trading a breakout or a retracement strategy. Today we will review using trendlines and Fibonacci retracements to trade pullbacks in price for trending markets.

Let’s get started!

Find A Trendline

Before we can consider trading a pricing swing, we need to first be able to find market direction as well as support or resistance. This issue can be solved by creating a trendline. These areas can be found on a chart by either connecting to highs or lows, then extrapolating their direction on the chart. In a downtrend traders should look for price action to be declining under trendline resistance, while in uptrend prices should be advancing above trendline support.

Below we can see a trendline formed on the USDJPY Daily chart. As the highs for this currency pair has been declining 12 2014 we can connect these values to form a point of resistance on our graph. This line will act as our price ceiling, and as long as price remains under this value we can look to find new opportunities to sell the market. This line can be left on the chart, and will be used as we continue looking for a market retracement.

Learn Forex – USDJPY Daily Trendline Resistance

The 3 Step Retracement Strategy

(Created using FXCM’s Marketscope 2.0 charts)

Fibonacci Retracements

Once market direction and trendline resistance is identified, we need to identify an area to enter into the market. This can be done by finding a confluence of resistance using a Fibonacci retracement. These retracement values are displayed as a percentage of the previous move as measured from swing high/low in a downtrend. Much like our previously drawn trendline, these retracements can pinpoint areas where the market may turn. Traders should look to see where these two values converge and then plan to enter the market.

Below you will find the established trendline on the USDJPY. The Fibonacci retracement tool has been added, and traders should take notice where the 78.6% retracement value meets our trendline. In the event that price retraces to this point, they can then plan to enter the market and look for price to return toward lower lows. Traders may sell the USDJPY with this strategy using market orders or utilize a preset entry order.

Learn Forex – USDJPY Trendline & 78.6% Retracement

The 3 Step Retracement Strategy

(Created using FXCM’s Marketscope 2.0 charts)

Exiting Positions

Now that we have a plan to enter the market on a price swing, traders will need to identify when it is time to exit the market. This is always the third and final step of any successful strategy! In order to manage risk, traders should first consider where to set a stop order. In a downtrend like the USDJPY daily chart, traders should consider placing this value above resistance. On the chart below stop orders have been placed outside of resistance, above our current trendline and previous swing high.

Lastly, we need to consider a take profit point. Traders should always look to use a risk/reward ratio to earn more profit on a successful trader, relative to a potential loss. This can be done by extrapolating a preset value relative to the stop value set above. Traders may also consider setting limit orders below the current swing low. In the event that our currency downtrend is to continue, by definition, price should continue moving towards lower lows down our graph.

Learn Forex – USDJPY Stops & Limits

The 3 Step Retracement Strategy

Check out these other 3 step trading strategies on DailyFX!

The 3 Step EMA Strategy for Forex Trends

A 3 Step Trading Plan for Channel Breakouts

---Written by Walker England, Trading Instructor

To contact Walker, email WEngland@DailyFX.com

Follow me on Twitter @WEnglandFX.

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