When it comes to stock market trading, most of us have sold or bought shares based on current conditions. If the price of a long-term stock we’re holding starts to decline, we start wondering if it is just a market hiccup or a real issue. In our haste, we end up selling the stock, only to find it price rise to an all-new high in a few days. While this scenario can be quite infuriating, it is also common. But such situations are commonplace in the trading world. That said, you can avoid them altogether by learning to identify the differences between retracement and reversal of stock prices.
Reversal is the change in the overall trend of a stock’s or asset’s price. It means that the price of the asset is more likely to continue to move in the reverse direction, for a prolonged period. The change in direction may occur to the upside following a downward trend, or the direction may move downside, following an upward trend. In most cases, the change results in a significant shift in the asset’s price. That said, there could be some pullbacks, leading the price to recover to its previous direction.
Unlike reversal, which can last for an extended period, a retracement is merely a temporary price reversal, taking place within a substantially larger trend. The keyword, here, is that the price reversal is ‘temporary’, which means there is no indication for a change in the overall, more significant trend. Upon reading a retracement chart, you will often find that when the price of a stock moves up, it can potentially make a new high, but when it drops, its starts rallying before reaching its previous low.
Retracement vs Reversal
The differences can be analysed based on six points.
Retracement is characterised by a small selling volume, in which retail traders typically take the profit. Conversely, reversal is characterised by a large selling volume involving institutional selling.
- Money Flow
In the case of retracement, the buying and selling interest during a decline and uptrend, respectively, continues to be present. For reversal, the buying and selling interest, during both decline and uptrend, are quite small.
- Chart patterns
With retracements, there are very few changes in chart patterns, which are usually limited to candlesticks. Conversely, with reversals, you will notice several reversal patterns such as head and shoulders pattern, double top patterns.
- Time frame
Retracement generally lasts for a shorter term, typically for no longer than one to two weeks, whereas reversal can last for a long-term, including more than a few weeks.
While fundamentals remain unchanged for a retracement, reversals entail a change or at least a speculation of a change.
Retracements are characterised by ‘indecision’ candles, which usually have long tops and bottoms, known as spinning tops. Reversal candles typically have engulfing, soldiers and similar patterns.
As is evident, it is quite common to confuse reversal vs retracement. However, if you are in doubt about a sudden change in the price of a stock, you can consult your investment advisor. At Angel One, we offer dedicated investment advisory services. We can also help you enhance your understanding of the stock market.