Retracement or Reversal – What’s the Difference?

(eToro Blog)  Given the perpetual ups and downs of the stock market, its not surprising than many new investors wonder if a drop in a stock price is a signal that its time to bail out or if they should just ride out a market blip. Analysts are always talking about retracements and reversals, but on the face of it they can seem one and the same. They are not, and it’s a wise investor who knows the difference and uses it to their benefit.

A retracement is simply a temporary price reversal that generally occurs within a larger trend it is not in and of itself a change in the trend which remains intact over the longer term. A reversal on the other hand, is a change in the trend’s direction, which is clearly recognizable in the price structure. Which is which? There are factors or clues which differentiate the two so that you can assess your next move.

Clue #1: During a reversal, volume is a factor of institutional selling whereas in a retracement volume is generated by retail traders’ profit taking.

Clue #2: During a reversal there is very little buying interest whereas in a retracement buying interest remains.

Clue #3: During a true reversal, the time frame will endure beyond two weeks whereas with a retracement a “false” reversal will be short-lived, generally of less than a week or two at the maximum.

Clue #4: During a true reversal, there may be talk of a fundamental change or a clear sign that a fundamental change has occurred, whereas in a retracement there will be no sign of a fundamental change.

Clue #5: During a reversal, clear reversal chart patterns emerge like a double top whereas in a retracement you will see very few reversal patterns.

There are, of course, other clues and indicators which can help a trader differentiate the retracement from a reversal. And, of course, there is also the possibility that a retracement turns into a reversal despite the criteria which suggests otherwise. If you can properly identify a stock price drop as a reversal or a retracement, you will be able to limit potential losses and preserve your gains.

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