V.14:2 (76-78): Quantifying Percentage Retracements by Alex Saitta

V. 14:2 (76-78): Quantifying Percentage Retracements by Alex Saitta

Traders often look for retracements of a market trend to establish new positions with that trend. But how often and how far does a market retrace the prior move before continuing? For the answer, this market analyst examines the Treasury bond futures market to determine typical retracement behavior.

When the market is in a trend, it often retraces a portion of the prior move before the trend resumes. When a correction begins and the market retraces a portion of the prior advance, traders who missed the previous advance enter the market and buy at this point. Then the trend resumes (Figure 1).

After an advance has been in motion for a lengthy period, latecomers start jumping in. These market participants buy not because they are compelled by strong technical or fundamental evidence; they buy because the uptrend has conditioned them to think the market will rise again tomorrow. Without strong reasoning, such traders lack conviction, so they will liquidate at the first signs of weakness. As soon as the advance stalls or the market drops slightly, these traders sell out, and in turn their liquidation triggers the start of a correction. Technicians believe a decline to at least the 33.3% retracement† level will follow as these latecomers dump their positions. Because of this, technical analysts have identified the 33.3% retracement as the minimum retracement.

After the 33.3% retracement level has been reached, technicians assume these participants have been flushed out of the market. Only then is it possible for the uptrend to resume. So at that level, the most bullish technicians re-enter the market, creating initial support in the area of the 33.3% retracement. Often, the trend resumes from there.