9-18 Retrace Forex Trading Strategy

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9-18 Retrace Forex Trading Strategy

Retracement entries are probably one of the best ways to enter a trending market. You get to trade with the trend, while at the same time having an opportunity to buy on the cheap. But what is it really and how do we exploit this market condition?

What is Retracement?

Retracements are practically short-term reversals on a bigger picture trend. On a bullish trending market, it is a slight dip in price that lasts only for a short while before continuing on the direction of the bulls.

Why does this occur? No one really knows. You would have to read the mind of the gazillions of traders who had a countertrend transaction at a specific retracement. But my theory is that these are points wherein those who have already made money out of the first burst of price movement cash in. To cash in on their profits, they’d have to make transactions opposite to their initial entry transaction to close out their positions. If you bought a currency pair and have profits on float, at some point you would want to realize some of those gains. So, you close your position. This closing of position is essentially a sell transaction. If many traders were thinking the same as you are, trying to cash in on some floating profits, that number of sell transactions would cause a dip in price. That is your retracement.

But because retracements are just slight pauses on the market the dip would minimal and the market would still have a very high probability of continuing the ongoing trend.

Retracements versus Reversals

While retracements are slight dips, reversals are the beginning of the end of an ongoing trend. In fact, reversal candles could sometimes be so strong, the trend don’t just end but it starts on opposite trend in a few candles.

But how do we decipher if the market structure is a retracement or a reversal. To be honest, no one would really know until it is done. But we could make an informed guess based on how the market is behaving.

One way to differentiate a retracement and a reversal is by identifying the location of the swing highs or lows in relation to the previous swing highs or lows. This is how price action traders determine a trend. If the market is constantly making higher highs and lows, then the market is said to be on a bullish trend. If it is a lower low and high, then it could be a bearish trend. If this pattern suddenly has a disruption, then the trend could already be ending. If on a bullish trend, a lower low has formed compared to the previous low, that is a sign of a market reversal.

The Easier Way

Many beginner traders find it hard to identify swing highs and lows. How much more identifying the trend through it.

But there is an easier way. It is through the use of moving averages as dynamic supports and resistances. By using two moving averages, we could anticipate the area in which price could retrace to. On a bullish trending market, the faster moving average should be above the slower moving average. The retracement area would be the area between the two moving averages. If price closes back above this area, then that it is a signal that it is probably just a retracement. But if price closes below this area, then we should be careful as it could be a sign of a reversal.

Trade Strategy Concept

Given the idea that moving averages could be used to determine retracement areas, we will be using this pullback area as the main basis for our setups.

On a bullish trending market, we will wait for price to retrace inside our dynamic area of support and resistance. Then, we wait for it to close back above this area before we enter a long trade. As for the short trade setup, we will just take the reverse setup.

To do this, we will be using the 9-period and 18-period Exponential Moving Average (EMA).

Timeframe: any

Currency Pair: any, even commodities

Session: any

Buy Trade Setup

Entry

  • The 9 EMA (gold) should be above the 18 EMA (green)
  • Price should be consistently above the 9 EMA
  • Wait for price to close below the 9 EMA but not below the 18 EMA
  • Enter a buy market order at the close of the candle above the 9 EMA

Stop Loss

  • Set the stop loss at the low of the entry candle

Take Profit

  • Set the take profit target price at 2x the risk on the stop loss

9 18 retrace forex trading strategy 01

9 18 retrace forex trading strategy 02

Sell Trade Setup

Entry

  • The 9 EMA (gold) should be below the 18 EMA (green)
  • Price should be consistently below the 9 EMA
  • Wait for price to close above the 9 EMA but not above the 18 EMA
  • Enter a sell market order at the close of the candle below the 9 EMA

Stop Loss

  • Set the stop loss at the high of the entry candle

Take Profit

  • Set the take profit target price at 2x the risk on the stop loss

9 18 retrace forex trading strategy 03

9 18 retrace forex trading strategy 04

Conclusion

This trading strategy is a commonly used strategy among traders, especially scalpers and day traders. But this is still very usable on the longer timeframes such as the 4-hour and daily charts.

If used for scalping or day trading, it would be best to trade this on high volatility and low spread currencies. This would usually be your majors. It is also best to trade on the session when one of the currencies’ market is open.

As all good things do, trends also come to an end. So, it is also good idea to take the first few pullbacks and forgo pullbacks on an already overextended trend. Some strategies take only the first couple of retracements while others would still take the third or fourth.

This pullback or retracement trading strategy is pretty aggressive as it only uses the dynamic support and resistance area without any filters. Some strategies would add other filters to it. However, it is also logical to use this type of setting if you are trying to catch the first few pullbacks because you would have lesser opportunities if you filter trades too much.

All in all, this strategy is pretty good. Especially because this is the type of strategy that many professional traders use.

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