Notes on Retracement Theory in Markets

 When the retracement of a rally is shallow, it indicates a stronger opinion of the shorter timeframe traders versus the opinion of the longer-term traders. Alternatively, if the longer time frame traders agree with the shorter timeframe traders (that the market is ultimately heading higher), they stand aside rather than fading the previous rally knowing that the 5-minute Bulls will exhaust themselves and prices will retrace. This is when they look to enter the market. If the price of com retraces less than 33% of the prior rally, then we could say that the 5-minute Bulls are stronger and/or the 15-minute traders agree with the shorter-term timeframe opinion. Should the Bears push the retracement to 50% or more, the 5-minute traders are probably being overpowered by a more powerful longer timeframe. Should the retracement be more than 66%, the traders in the shorter timeframe that caused the price movement would be in trouble


When looking at a price chart, it is readily apparent that prices fluctuate up and down. These fluctuations seem to occur at random. As you become more comfortable working with the concept that there are multiple timeframes being reflected in any chart, this apparent randomness becomes more understandable. However, it is important that you understand when price retraces its prior move and finds support or resistance at 14.6%, 23.7%,38.2%, 50%, 61.8%, 76.3%, or 85.4%, the market is telling you that it has "discovered" a key number. This is a key number that you should remember when placing your trailing stop. 



If the market is rallying, we can expect that at some point the Bulls will get tired and prices will retrace a part of their preceding rally. This retracement will be more than 5.5% and less than 38.2% of the move, if the trend is strongly up. If the trend is moderately strong, the retracement will be 38.2% to 50%. The retracement will be between 50.0% and 66.7% if the trend higher is in danger of failing. If the retracement falls between 66.7% and 85.4%, the trend has a high probability of failing.


For our purposes, there are three types of basic retracement - shallow, medium, and deep. Understanding basic retracement theory will help us to identify whether a trend is



 strong, moderate or weak by the percentage of its retracement. In addition to basic market retracement, there are complicated retracements that involve multiple timeframes consisting oflonger or shorter time cycles. These complicated retracements will not be discussed in this book. Before using retracement theory, we must allow the price to move a certain amount of points and time. For example, if we are following a rally in the S&P and are looking at a 30-minute chart, then we want the rally to move more points and last longer than on a 5-minute chart before attempting to use retracement theory 


In an uptrend or bull market, 

the RSI tends to remain in the 40 to 90 range with the 40-50 zone acting as support. 


During a downtrend or bear market the RSI tends to stay between the 10 to 60 range with the 50-60 zone acting as resistance.



The price is where traders of different timeframe perspectives and capitalization levels come

together in an instant of time agreeing on a certain price. In order to understand

where prices are going, it is important to understand which "time perspective" is

the stronger force, and then go with that force.

"The FORCE is more your friend than the trend


1. In uptrends, the RSI will find support at 33.33 and resistance at 80. 

2. In down trends, the RSI will find resistance at 66.67, and support at 20. 


Using the 80/40 and 60/20 range rules, we can instantly identify the trend the majority of the time. 

If the RSI is staying within the 80/40 ranges, we know that the trend is up, and the majority of the "other" 

traders are also looking at this same time frame. If the RSI is staying within the 60/20 ranges,

 we know that the Bears are in control and the trend is down


An Uptrend is indicated when: 1. RSI values remain in an 80/40 range 2. The chart exhibits simple bearish divergence 3. Hidden bullish divergence are seen 

A Downtrend is indicated when: 1. RSI values remain in a 60/20 range 


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