What is Trading Market Environment? Trend Retracement or Reversal the Facts?

Understanding Trading Environment in Markets

When it comes to trading, it is essential to have an idea of the kind of market environment one is dealing with. Just like going to war, one does not go blindly without a plan. A wise man will always take time to understand the situation to know the surrounding conditions that would affect the battleground.

Experienced forex traders take time to figure out a strategy, ideal for a given market environment. Deciding which strategies to use depending on the trading environment is crucial if one is to squeeze optimum profits from the market.

By understanding the market environment, one can choose a trend-based strategy to deploy in a trending market or a range-bound strategy in a ranging market. However, before deploying any trading strategy, one must determine the trading environment, classified into three; trending up, trending down and range-bound.

Trending market

A trending market, for instance, is one in which price moves in one direction, which could either be up or down. While the price may go against a trend now and then, the longer time-frame will most of the time show that those were just retracements and that the price continued to move in one direction.

 Range-Bound Market

A range-bound market, on the other hand, occurs when the price bounces in between specific high price and low price. A high price would act as a resistance curtailing further upside action while a low price would act as support curtailing further downside action.

Trend Reversal- retracements

A trend reversal environment occurs when the price starts to rise, keep rising but eventually starts to fall. After falling some more, the price might start to go up. A retracement is essentially a price movement against an established trend.

Retracements occur when price moves against an established price movement but returns to continue the trend.

What is a Trending Market?

What Is A Trending Market?

The term trending market is mainly used in Forex and stock trading to indicate a situation where a chart is generally flowing in a certain direction.

A trending market is characterized by a generally bullish (upward) or bearish (downward) trend. However, the price has moments where it goes against the trend, but then the overall direction prevails. Instances, where the price reverses or goes against the trend before getting back to the general trend, are called retracements.

The importance of liquidity

A bullish trending market is characterized by “higher lows” and “higher highs” while a bearish trending market has “lower lows” and “lower highs.” Traders whose strategies are based on trending markets mainly opt for major currencies or any other currency that leverages the U.S dollar.

Such currency pairs are ideal for trending market strategies because they are characterized by more liquidity compared to other currency pairs. Liquidity plays a vital role in the success of a strategy that is based on a trading market. This is because more movement will likely occur when the currency pair is highly liquid.

More opportunities are likely to occur when there is more movement in a currency pair that has a high level of liquidity where the price moves strongly in one direction. A currency pair that contains currencies that are not strong will likely have the price playing around in small ranges.

Technical tools

Some traders rely on price action, but technical analysis is ideal for a better view of the market’s performance. Technical analysis involves the use of technical tools otherwise known as technical indicators to observe the market, determine the trends, and fine-tune your execution. Technical tools can help you identify a trading currency pair.

There is a wide variety of technical tools out there, and the most common ones include Bollinger bands which are great for discovering trends and also for strategies that are based on range. Bollinger bands are considered the best technical analysis tools for measuring deviation.

Another set of technical tools used to determine the trend direction are the moving averages, such as the Simple Moving Average (SMA) and the Exponential Moving Average (EMA). Note that there are many other technical indicators that you can use to improve your trading.

What is a Range-Bound Market?

What is Range-Bound Market?

A market where price seems to be stuck between a specific range that has a high and low price range is known as a range-bound market.

A range-bound market is the type of market where the terms “support” and “resistance” really come into play. A high price level where the price seems to reverse multiple times is known as a “resistance level.” The opposite is a low price level that the price seems to reverse at multiple times, and this is known as a “support level.”

A range-bound market is easily identifiable as a situation where the overall trend seems to be moving in a sideways or horizontal trend. It is easy to pinpoint the highs and lows, and these help traders to form the trend lines which they can then use to determine ideal entry points and exit points.

Best technical tools for a range-bound market

The Average Directional Index indicator (ADX) is one of the best tools to determine a ranging market. The ADX value goes below 25 in a ranging market. Keep in mind that the ADX value goes down as the trend weakens.

Another vital tool for a range-bound market is the Bollinger bands which expand in a highly volatile market and contract in a low-volatility market. A range-bound market will, therefore, have contracted Bollinger bands because a tight range will characterize the price. This makes the Bollinger bands ideal for a breakout strategy.

Buying and selling in a range-bound market

The trader uses technical indicators as mentioned to identify the support and resistance levels. The trader can then buy when the price approaches the support level and sell when the price approaches the resistance level.

Overbought and oversold conditions

You can refine your strategy by making use of technical indicators that are designed to show situations where the currency pair has been overbought or oversold. Some of the technical indicators that are ideal for this include the Relative Strength Index (RSI) and Stochastic Oscillator. The role of these oscillators is to help the trader determine possible turning points within the overbought and oversold conditions.

Note that the range-bound strategy is ideal for currency crosses. This means currency pairs that exclude those involving the USD.

Trend Retracement or Reversal?

What Is Trend Retracement and Reversal?

Reversals and trend retracement as the name suggest refers to situations where the price switches the direction from which it was previously trending. However, the two have distinct differences.

When the price starts changing directions, it is essential to identify whether it is a trend retracement or a reversal. Understanding the difference between the two might help you avoid placing wrong trades that may end up making you lose your hard-earned money.

Understanding trend retrenchment

Picture a situation where the overall price trend is bullish, but then it pulls back in the opposite direction briefly before continuing on its bullish trend. This kind of situation is called a trend retrenchment, and it also happens in a bearish trending market where the overall trend has a falling price, but then the price starts going up briefly before going down again.

Understanding reversals

A reversal occurs when there is a definite change in the price direction in a currency pair. For example, if a bullish trend changes to a bearish trend, then that is a reversal. The same also applies when a bearish trend turns to a bullish trend.

Here is an example of reversal:

Getting things right

The idea of riding the forex wave successfully is one that many forex traders dream of especially when it comes to reversals. If you can execute your trade at the ideal time that a trend reversal starts happening, then you can make decent returns, especially if it’s a long reversal. However, the problem is that traders often bet on a reversal but end up being trapped by trend retrenchments.

There is no 100% accurate way of knowing which direction a trend will take. However, if you play the cards right, you can keep making money. One of the best ways to handle trend reversal and retrenchment situations is to use risk management methods such as stop loss. This refers to points on the chart where you are willing to close your position to avoid further losses.

How to Identify Reversals

Ways to Identify Reversals

Properly distinguishing between reversals and retracements can help increase your chances of winning trades and even reduce the disappointment of losing trades. It is very vital to classify a price movement as a reversal or a retracement.

There are numerous key differences in differentiating a long-term trend reversal from a temporary price change retracement. They can be explained as:

• Retracements usually are noted after huge price movements, whereas reversals can happen at any time.
• Retracements are short-term, while reversals are all about long-term price movement.
• In retracements, fundaments do not change, whereas in case of a change in fundamentals lead in long-term reversal.
• Retracements are supported by the interest of traders as per the trend. When it is an uptrend, more buying can be seen, and the same stands true when the market declines. However, in the case of a reversal, there is less little buying interest in the event of an uptrend, making the price to decline.

Fibonacci Retracement

One of the prevalent ways to identify retracements is Fibonacci levels. Mostly, price retracements are seen close to the 38.2%, 50%, and 61.8% Fibonacci retracement points before extending the overall trend. When price moves beyond these points, it indicates a reversal.

In this example, the price took a halt at the 61.8% Fibonacci retracement point before starting the uptrend. After some time, it hovered close to 50% retracement point before moving higher.

Pivot Points

In case of an uptrend, you can note the lower support points and wait for them to break.

In the case of a downtrend, higher resistance points come into play. They are looked upon to identify a trend breakout.

Trend Lines

Another method used to identify reversals is trend lines. You know there is a reversal in price when a major trend line gets broken.

Protect Yourself From Reversals

How to Protect Trades from Reversals?

Reversals can happen at any time and may result in price erosion. It is therefore extremely important to use basics while trading retracements, as they can change into reversals without any warning. You should always use stop loss while trading retracements as the first rule of trading is always to preserve your capital. Using a stop-loss order implies that if the price declines to a certain set level, the trade will be automatically closed at the current price, to limit further losses.

If you are making profits on trade and expect it to continue, it is best to use a trailing stop loss. This way you can avoid yourself from closing a trade too early in case of retracement.

You can improve the effectiveness of a stop loss by coupling it with a trailing stop loss. In the case of trailing stop loss, stop loss is fixed at a certain percentage below the market price. In case of the price surges, it moves the trailing stop too. Once the price stops surging, the new stop remains at the point it was moved to, thus protecting the downside.

You don’t have to suffer by blindly following the retracements. You have to make use of stop loss and trailing loss to protect all those pips and lock the profits.

Identify the ways to differentiate between reversals and retracements. This is part of the learning process as you trade in the market. With lots of experience and practice, you will learn the art of trading as per the retracements level and close the trade in profits.