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Is it a reversal or just a retracement?

Written by Bybit Analyst Dhiresh Manji Dabasia

Have you ever been caught in the trap of a trade being well in profit, and then your emotions kick in and you think this is a reversal, but then very soon find your trade has turned and is now back near entry or even in a loss?

This is a very common habit and often occurs when traders do not know the difference between retracements and reversals and do not pay much attention to the higher timeframes, to gauge the market structure. Today I will take you through the difference in reversals and retracements and explain how I use the fibonacci retracement tool when analysing the markets.

Retracement vs Reversal

A reversal is a point in the market when a long-term change in direction is likely to occur. To spot reversals it is essential to monitor higher timeframes (Yearly, monthly, and weekly) for multiple confluences for a reversal, such as a candlestick pattern in an area of historical support or resistance with added confirmations on smaller timeframes such as daily or 4HR with trendline breaks or other crossovers.

In addition to this, it is important to remember that reversals will often occur in unique spaces on the chart; i.e. an area which price has not visited before. A very recent example, which is shown below was the BTCUSD sell off in December 2017, which was a unique space on the chart, double top area and also round number resistance at 20,000.

On the other hand, a retracement is usually a phase in the market where a short-term change in direction occurs and is usually a temporary movement but can be a phase which takes a long time to complete. A very effective way to spot retracements is using Fibonacci retracement levels. The key levels at which a retracement tends to occur are, 38.2%, 50%, and 61.8%, and when these levels are hit with other confluences a trader should monitor closely to enter in the direction of the longer-term trend.

Concluding I believe although there is risk with trading a retracement, if it provides a good risk to reward ratio (minimum 1:2), then a trader may take on the trade if and only if all their trade criterion is met.

Fibonacci Plays

Fibonacci levels arise from ratios obtained through the addition of congruent added numbers. These ratios were famously found by mathematician Leonardo Fibonacci. Fibonacci ratios occur naturally all around us without actually knowing. A few examples are pine cones, cauliflower, shells and even some leaf arrangements.

The ratios arise from the following sequence: 0,1,1,2,3,5,8,13,21,34,55,89… As you can see each number arises from the addition of the previous 2 integers, starting with 0 and 1. If we continue this sequence to higher numbers, taking to consecutive numbers, the first divided by the second will give 0.618. This is known as the ‘Golden ratio’, and when it comes to trading this is a key retracement level which I monitor.

There are a few more Fibonacci levels which are: 0.236,0.382,0.500,0.618,0.763. Personally I tend to find that 0.236 and 0.763 are not very significant when it comes to retracements. Instead, I find that the 0.382, 0.500 and 0.618 are the high probability retracement levels when used alongside support and resistance levels, and other confluences.

Many people ask me how I determine my targets when I take a trade. The answer is not simple, but one thing I do pay attention to is Fibonacci extension levels. They are the -0.27 and -0.618 levels which are my targets when confluent with either support or resistance levels. The Fibonacci retracement levels and extensions I have talked about can be seen in most of my charts which is where you will be able to see why I use these specific levels.

When taking Longs, the fibonacci retracement tool is draw from low to high from the previous low to the most recent as shown below.

As you can see above, currently ETHUSD is part of a fibonacci move where we had the move from A to B followed by the retracement into the Willis zone (space between 50% and 61.8%) and we now expect to go and achieve target D1 at -27.2% extension.

On the other hand, when looking to take shorts, the fibonacci is draw from most recent high to low as shown below.

As you can see above this fibonacci play went on to hit D1 after a 50% fibonacci retracement.

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