The Power of Retracements

02/10/2014 11:12 am EST

Focus: TOOLS

Corey Rosenbloom

Founder and President, Afraid to Trade

Fibonacci retracement is a popular tool many traders use, according to Corey Rosenbloom, who explains how to use retracements when a trend is in place.

TIM:  My guest today is Corey Rosenbloom.  We're talking about retracements and how you use them to find good opportunities in the market.  So Corey, first of all, let's go ahead and start by defining what a retracement is. 

COREY:  Absolutely, Tim.  A retracement requires a trend to be in place, and for the conversation here we'll just take it in terms of up trends or bull markets or rising trends.  Higher highs, higher lows, rising moving averages.  Those are quantifiable methods with which we can use.  A retracement trade takes place typically if traders look at Bollinger Bands, standard deviation bands.  When a market rallies to the top of a Bollinger Band, typically the market will pull back or retrace to a moving average, 20, 50, whatever the case may be, or a Fibonacci retracement, so there are different metrics, different objective methods to use to quantify pullbacks and to find entries into a trend environment. 

TIM:  I'm glad you talked about entries because a lot of traders I think look for a 618 Fibonacci line or a moving average.  They want that to hit it and retrace to the tick and then bounce right off, and rarely does that happen, so how are you using it to really find a good entry point?  Is it a zone more so than an exact target, or what do you do? 

COREY:  Typically I look for confluence, so I look to use multiple methods.  For example, a rising moving average, possibly a hand drawn trend line or a Fibonacci as you mentioned zone, not so much an exact point, an exact tick.  That doesn't really happen in the real world.  If it does, it's ideal and put into a textbook.  That's not the way it works in the trading world and the real community, so what I look for is multiple factors that are aligning at the same level within a margin of error.  I also look for reversal candles. 

For example, bullish hammers or even doji candles.  Those are the patterns for the candle metric.  We also can draw up the more advanced, to be a little bit more professional, can draw up, say we have a retracement to a support zone on a daily chart.  We can thus look to a 15, 30, or even hourly chart to find any sort of positive divergences, breakout signals, or other potential things we would not see on a daily chart as price interacts with that level. 

TIM:  Okay, so you're looking for a few things to come together.  The question then becomes is how many.  Do I need three things to agree, four things, and how many is too many? 

COREY:  Well, once again in textbook sense, the things that are perfect get put into textbooks but don't work in the real world, so as traders we have to embrace uncertainty and then really embrace this probabilistic environment where we don't know what's going to happen, so as a trader, a new trader typically should wait for as much variables as possible and enter as a conservative trader.  What that means is finding a reversal candle and trading on the breakthrough of a trend line.  For example, a falling bull flag or an aggressive trader doesn't need an additional confluence.  They might not need that reversal candle.  They may execute as price touches a certain point and be done with it.  Their stop typically is closer and their distance toward the target, the prior swing high at a minimum is larger than a conservative trader's entry which will demand price rally up off of that level. 

TIM:  Corey, thanks for your time. 

COREY:  Thank you, Tim. 

TIM:  You can find out more about Corey at AfraidToTrade.com.