What it means in trading, with examples

What is a withdrawal?

A retracement is a pause or moderate decline in a stock or commodity price chart from recent peaks that occurs within a continuing uptrend. A withdrawal is very similar to withdrawal or consolidation, and the terms are sometimes used interchangeably. The term retracement is usually applied to price declines that are relatively short in duration—for example, a few consecutive sessions—before the uptrend resumes.

What does a retreat say to you?

Pullbacks are commonly seen as buying opportunities after a security has experienced a large upward price movement. For example, a stock may experience a significant rally following a positive earnings announcement and then experience a pullback as traders with existing positions take the profits off the table, that is, sell some or all of their long positions. However, the positive earnings are a fundamental signal that suggests the stock will resume its upward trend.

Most retracements involve a security price moving down to an area of ​​technical support, such as a moving average, pivot, or Fibonacci retracement level, before resuming the uptrend. Traders should keep a close eye on these key areas of support, as a breakdown of them could indicate a reversal rather than simply a pullback.

Example of how to use a pullback

Pullbacks usually do not change the underlying fundamental narrative that drives the price action on a chart. These are usually profit-taking opportunities after a strong rally in a security’s price. For example, a company may report blowout earnings and see shares jump 20%. The stock may experience a pullback the next day as short-term traders lock in profits by selling some of their long positions. However, the strong earnings report suggests that the company underlying the stock is doing something right. Buy-and-hold traders and investors are likely to be attracted to the stock by the strong earnings reports, which support a sustained near-term uptrend.

Every stock chart has examples of pullbacks within the context of a long-term uptrend. While these declines are easy to see in hindsight, they can be more difficult to determine for investors holding a security that is losing value.

In the example above, the SPDR S&P 500 ETF (SPY) experiences four pullbacks within the context of a long-term trend higher. These pullbacks typically involved a move to near the 50-day moving average where there was technical support before a pullback higher. Traders should be sure to use several different technical indicators when assessing pullbacks to ensure they don’t turn into long-term reversals.

The difference between a reversal and a pullback

Pullbacks and reversals both involve a security moving from its highs, but pullbacks are temporary and reversals are longer term. So how can traders distinguish between the two? Most reversals involve a change in a security’s underlying fundamentals that forces the market to reevaluate its value. For example, a company may report disastrous earnings that cause investors to recalculate a stock’s net present value. Likewise, it could be a negative settlement, a new competitor releasing a product or some other event that will have a long-term impact on the company underlying the stock.

These events, while occurring off the chart so to speak, will appear over several sessions and will initially look a lot like a pullback.

Limitations in Trading Withdrawals

The biggest limitation of trading pullbacks is that a pullback can be the start of a true reversal. Since both retracements and reversals occur on a variety of time frames, including intraday if you want to go granular, one trader’s multisession retracement is actually a reversal for a day trader looking at the same chart. If the price action breaks the trend line for your time frame, you may be looking at a reversal rather than a pullback.

In this case, this is not the time to enter a bullish position. Of course, adding other technical indicators and fundamental data scans to the mix will increase a trader’s confidence in distinguishing pullbacks from true reversals.

The Bottom Line

Pullbacks are a normal part of any sustained uptrend. They can be caused by profit taking after a sudden rise in the price of a security, or some minor negative news about the underlying security. Trend-following traders often use pullbacks to enter the dominant uptrend, or to add to existing longs. They can do this through buy limit orders, stop buy entry orders, or just a regular market order if they want to jump in right away.

Retracements usually stabilize or find a short-term bottom at resulting technical levels, such as a daily moving average, a Bollinger band or a Fibonacci retracement, to name just a few technical support levels. It is important to note that if these support levels fail, you may be looking at a larger correction, or even a full reversal.

Traders should look at other indicators, such as momentum oscillators like the RSI, to see if there are any bearish divergences that could indicate a deeper correction. But if the fundamental picture for a company or currency has not changed significantly, it increases the likelihood that this is just a normal pullback that should stabilize over a few sessions, offering buyers a chance to buy at a cheaper price. price to enter the primary uptrend.