Trading with Retracement Strategy

In general, strategies for entry or exit can be done in 3 ways: breakout when the market is trending, bouncing when the market is sideways, and taking advantage of price movements during corrections or retracements that usually occur in trending markets. As is known, in trending conditions, corrections typically follow, as seen in the Elliot wave pattern.

This article illustrates a simple trading method by taking advantage of price movements during retracements or corrections. There are 3 steps: drawing a trend line, determining Fibonacci retracement levels, and establishing entry and exit levels (stop loss and take profit or limit). Below is an example on USD/JPY daily that is starting to reverse from uptrend to downtrend.

1. Determining the trend direction and drawing the trend line

The first step is to determine the trend direction. Besides observation, we can confirm the trend direction with price action, where for an uptrend, the swing points will form a pattern of higher highs or higher levels than the previous high and higher lows or higher levels than the previous low, while for a downtrend, the swing points will form a pattern of lower highs or lower levels than the previous high and lower lows or lower levels than the previous low.

After knowing that the current movement is a downtrend, we connect at least 2 nearby peak price points (high) (points A and B) as a downtrend line that also functions as resistance. Since it is moving downtrend, we look for opportunities to open a sell position by waiting for the price to pull back to start the correction.

2. Determining Fibonacci retracement levels for entry

After the price starts to retrace (correct) by moving towards an uptrend, we determine the Fibonacci retracement levels with the swing high at the nearest high level (point B) and the swing low at the lowest level when it starts to retrace (point C). The retracement levels we pay attention to are 50%, 61.8%, and 76.4% because retracements usually end when the price reaches these levels. Entry can be made with a market order (according to the price at that time) or a pending order. Since we will open a sell position, we choose the highest price at the Fibonacci retracement level of 76.4%.

3. Determining stop loss and limit (take profit) levels

With the initial conclusion that the price is moving downtrend, we set the stop loss level a few pips above the nearest high level (point B). As seen in the image above, we can still determine a risk/reward ratio greater than 1:2 by placing the limit or take profit level at the lowest level when the price starts to correct (point C).