Most stock market traders have bought or sold shares based upon current conditions. We start to wonder if the decline in price of long-term stocks we own is a market glitch or a serious problem. We sell the stock in our haste only to see its price rise to a new high within a few days. This scenario is not uncommon, but it can be frustrating. These situations are not uncommon in the trading industry. However, it is possible to avoid these situations by understanding the difference between retracement or reversal in stock prices.
A change in the overall trend or price of an asset or stock is called a reversal. This means that the asset's price is more likely to move in the opposite direction for a longer period. A downward trend may lead to a change in direction, while an upward trend may see a shift to the downside. Most cases, the change in direction results in a substantial shift in the asset’s price. However, the price could recover in its original direction if there are some pullbacks.
A retracement, unlike a reversal which can last for a longer period of time, is only a temporary price reverse, occurring within a larger trend. Here, the keyword is "temporary" which means that there is no indication of a change in the larger, more important trend. A retracement chart will show that a stock's price can rise to a new high. However, if it falls, it starts rallying back before it reaches its previous low.
Six points can be used to analyze the differences.
Retracement is characterized by low selling volumes, where retail traders usually take the profit. Reversal, on the other hand, is marked by large institutional sales volumes.
2. Money Flow
Retracement is when the buying and selling interests during a downtrend and an uptrend continue to exist. The buying and selling interest during both a decline and an uptrend are very small for reversal.
3. Chart patterns
Retracements are limited in the number of changes to chart patterns. These are typically limited to candlesticks. Reversals on the other hand, will show you many reversal patterns, such as double top and head and shoulders patterns.
4. Time frame
Retracement lasts for a shorter time, usually for one to two weeks. However, reversal can be long-lasting, sometimes lasting for several weeks.
Fundamentals may not change for a retracement but reversals can indicate a change, or at the very least a speculation of a shift.
Retracements are characterized by "indecision" candles. These candles have long tops or bottoms, also known as spinning tops. Reversal candles are often characterized by engulfing soldiers and similar patterns.
It is common to confuse reverse vs. retracement, as is obvious. If you have any doubts about sudden changes in stock price, consult your investment advisor.