Aaron
Lynch

In this week’s article I want to cover the concept of retracement trades. Looking at the XAO we can see that over the last 12 months there has seen a significant downward movement. With three major runs down and of recent times a rally against the prevailing trend.

The market is trading at levels last seen in 1998. So if we believe that we have found some support how do we enter the market in times like this? We can use a retracement trade - a retracement is simply a movement against the prevailing trend.

An abnormally sharp rise or fall cannot be sustained indefinitely in established markets - we must see the gains or losses given back to a point. The current market sees the scenario where we have had very steep runs into the March 2003 low and a steep climb out to where our market is currently trading. We are starting to see the market slow in its progression as the market starts to trade sideways from the orange trend line below. So we can say that the market’s momentum is falling.

We can use the oscillator indicator to confirm the slowing in the speed of the market.. This measures the speed of the move regardless of direction, or the rate of change in price without focusing on the actual price. Looking at the XAO we can say that after its strong run in and out of the March low it is losing some of the upward momentum. This can occur for a number of reasons; traders may be taking profits for example.

To confirm that the market is forming a retracement rather than a downtrend, we can use the oscillator levels for confirmation. We would like the oscillator to retrace to a level around 90% of the oscillator range and even move through the zero line. However, if it travels too far through the zero line we may find that the stock is actually in a new downward trend and not merely retracing. This is a critical point to watch.

So combining the signals that the oscillator is providing and with the use of a simple trendline, we can enter into a retracement trade. There are other tools like the Gann and Fibonacci retracement tools to assist us in identifying possible support in price but that’s for another time.

With the XAO forming this pattern we can be assured that there are a number of large companies that are also forming a similar setup. So we are looking for companies that are slowing in momentum and forming a new base in price.

Good Trading

Aaron Lynch