The new retrace again takes further information to try and confirm the likelihood of the retrace happening, rather than just trading range bound and hoping that it never breaks out. Again, this is something that you will look at when the chart you are following reaches the resistance level. In general, we are looking to short the stock, as we think it will come back down.
The new retrace involves looking at other indicators to see if they support that view. However, before we do that, we want to draw a line from the current price to the left, and see how many times the price has reached here and backed off, and whether there were any interesting trading patterns associated with them. We generally want to find patterns that worked more often than not in the past, for this particular stock.
As with the bounce example, we want to look for signs in the candlesticks that a change or reversal is about to take place, and I’ll give you some more candle tips later in this book. If you remember the basics of what they mean, you’ll get a good idea of the signs. A short candle body, or even a Doji, is a sign of change, as different prices may have been tried during the day, but the price returned to where it started. Obviously, near Dojis – short real bodies – are similar but not so strong in meaning.
On the other hand, you may see some indecision in the form of the candlesticks. If the wick gets longer, breaching the resistance line, it shows that traders were trying a higher price, and there is some willingness to breakout. You may need to be cautious if this is the case. The converse, when the lower shadow gets longer, is a good bearish sign, and means that people are trying to push the price down – in fact, it shows that someone has already sold at, and bought at, a lower price.
We can look again at the Relative Strength Indicator (RSI) for some confirmation. The RSI compares the average up move with the average down move, so if it is high, say 70% and above, that is an indication that the stock is overbought. You can check the normal levels that this stock retraces at, by seeing what the RSI was previously when the stock started to retrace – you may need to wait to 75% or 80% to find the best turning point. While the RSI is not a complete trading indicator – in fact, and you should know this by now, nothing is a complete standalone indicator no matter how complicated you make it – it can give you a good confirmation of something that you are already suspecting. Of course, if it isn’t up at 70%, but around 50% or less, that’s indicating caution, because the stock is not behaving in a predictable manner.
The danger with a retrace trade is that stocks will, from time to time, breakout of the support and resistance channel, and start at a new level. As you are trying to trade on the basis that the price is in a tight band, it is easy to set your stop to prevent too much loss, if this happens. Just look at where the candle wicks have been going, and set the stop a bit outside that – say twice as far above the resistance line – so that you cut off your trade as soon as it seems to be going the wrong way. You can also look at the ATR, described in the bounce, if you want to get more technical.
If the value does retrace, and you have gone short, you want to have a target price in mind. Again, you can use The Fibonacci tool to see what specific targets you can have for the price, or you can just take, say, half profits at 50%, and try riding the price down further, say to the 68% line, with the other half. In time, the support and resistance theories say that the price will drop to the support, but of course, it won’t necessarily go all the way, so you will need to trade out without waiting that long.
The short trend, in contrast to the long trend, is the most recent part of the price movement. For instance, if the price is oscillating between support and resis-tance at a particular time, and drops to approach the support, the short trend is that im-mediate drop. It represents the market’s most recent feeling about the particular stock, and is important as we can use it to set a profit target.
The way we do that is to extend the Fibonacci lines from support up to the last high, and take a view on which line the stock is aiming for – when going long, up from support, it’s frequently the 38% or 50% lines, and going short it may be 50% or 62%.