Retracement refers to price reversal after reaching a recent high or low, finding an area of support or resistance, and then continuing in the direction of the bigger picture trend. The concept of 50% retracement is based on the work of W.D. Gann.
Gann was born in 1878 in Texas. Over his trading career, it's been stated he was one of the most successful traders who ever lived. With that said, there is no irrefutable proof he made great fortunes in the market. However, it's a fact that his trading ideas and principles are still in use today, many years after his death in 1955.
Gann believed there was a natural order that exists for everything in the universe, including the stock market. He theorized that price movements occurred in a manner that can be pre-determined based on historical precedent and the influence of mathematical equations and relationships. The end result was predictable movement of prices between areas of support and resistance.
The idea of 50% retracement is best explained in this quote from Gann:
"After an initial, sustained price move, either up or down, prices retrace to 50% of their initial move."
What's important here is the idea that retracement applies in both directions. When price is heading up, it may be approaching an area of resistance. When price is declining, it may be heading towards an area of support.
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Continuation of the Trend
The primary reason we are interested to gauge levels of retracement is that once a retracement is complete, there is often a continuation of the previous trend. For example, if moving from a recent low to a new high, if price retraces 50%, at that point we look for a bounce and a continuation of the upward trend.
Retracement to Area of Support
When moving a recent low to a recent high, one can anticipate a price to move down 50% of the original move up.
For example, if a stock climbed from $50 to $100, a 50% retracement of the move from low to high would result in a price of $75. We now look for this $75 price area to be an area of support.
Retracement to Area of Resistance
Retracement is also applicable in the other direction. If price moves from a recent high to a new low and starts moving back up, look for price to regain 50% of the original move down. This retracement is often an area of resistance.
For example, if the recent high was $100 and price bounced off a low of $50, look for resistance near $75.
Additional Retracements - 33% and 66%
Gann also focused on other incremental retracements that he calculated based on various geometric angles believed to balance price and time. What I've found most helpful is to keep things simple and focus on no more than three retracements, 33% 50% and 66%.
Direction of Retracement
When moving from a recent low to a new high, the retracement will be downward. If multiple retracement percentages are shown, they will be smallest to largest going from the top to bottom.
When moving from a recent high to a new low, the retracement will be upward. If multiple retracement percentages are shown, they will be smallest to largest going from the bottom to top.
Retracement Versus Reversal
As described above, retracement refers to retracing a move back down towards a recent low after hitting a new high, or moving back up from a recent low towards a previous high.
The difference between a retracement and reversal is that the latter breaks the uptrend as shown in the chart that follows:
■ With retracements, the upward trendline acted as support of the upward trend.
■ With a reversal, the upward trendline was broken and the price continued to move down.
Additional Retracement Examples
■ Choose up to three retracement levels, 33%, 50% and 66%.
■ Set preferred lookback count for Marked Highs/Lows.
■ Configure Marked Highs/Lows line styles and colors.
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