Technical Analysis


What is a pullback?

A retracement is a technical term used to identify a small pullback or change in direction in a financial instrument such as a stock or index. Retracements are temporary in nature and do not signal a shift in the larger trend.

key takeaways

  • A retracement is a small pullback or change in the direction of a financial instrument, such as a stock or index.
  • The term technical analysts use to analyze security prices refers to short-term changes in a stock’s price relative to the general trend.
  • Once the retracement is over, it should continue the previous trend.
  • A retracement is not the same as a reversal – for the latter, the price of a security must break through a support or resistance level.

Learn about drawdowns

A retracement is a temporary reversal in the general trend of a stock price. Unlike a reversal, a retracement is a short-term movement against a trend followed by a return to the previous trend.

The chart below shows the stock price of General Electric Company. It shows that the stock is in a downtrend. However, there are points on the chart indicating that the price is rising, which would be considered a retracement.

The retracement itself doesn’t say much. However, when combined with other technical indicators, it can help traders determine whether the current trend is likely to continue, or if a major reversal is underway.

Retracements should be used in conjunction with other technical indicators, not alone. If used incorrectly, it may lead to analysis errors.

Retracement and Reversal

Identifying the difference between a reversal and a short-term retracement is crucial. A retracement is not easy to identify because it can easily be mistaken for a reversal. Worse yet, if a reversal is mistaken for a retracement.

The chart below shows that the S&P 500 saw a notable uptrend between April and October in 2018. Three retracements were identified on the chart, although there were also a series of smaller retracements as the S&P 500 was on its way to a new all-time high.

The bottom line is that the retracement never broke out of the uptrend. However, in October, what appeared to be a pullback turned into a reversal after the index finally broke below its uptrend, leading to a sharp decline.

Again, it’s important to remember that a retracement is a small or short-term pullback in the price of a stock or index. The point is that the stock did not break out of a key level of support or resistance, nor did it break out of an uptrend or downtrend. If the price falls below or exceeds a support or resistance level, or violates an uptrend or downtrend, it is no longer considered a retracement but a reversal.

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