Find A Trend With The Partial Retrace

By Joey Fundora

Identifying when a change in trend is occurring is one of the most important skills a trader can learn. There are several methods that can be used to
identify a possible change in trend; however, one of the easiest to spot is the emergence of a new pivot point. While identifying a pivot must always be
done in hindsight, one can examine clues on a chart to determine whether the probability of forming a new pivot is high. One technique is to watch for a
partial retrace after a trading range has been established.

When a stock refuses to honor an established range, it usually reverses to break the trading range in the opposite direction, thus establishing a new

pivot point. By picking a bottom, a trader can benefit by getting in early on a new trend. In this article we will discuss concepts from a long (uptrend)

perspective and using stocks as the financial instrument. For shorting, apply the same concepts in reverse. These concepts will work for any instrument

that can be charted, as they simply measure the psychology of the market participants.

Identifying a Partial Retrace

There are three basic trends for stocks: uptrend (moving higher), downtrend (moving lower) and consolidation (moving sideways). A stock in an uptrend

is defined as making higher pivot highs, and higher pivot lows.

Figure 1: A downtrend and an

uptrend
Copyright
Figure 2: Sideways trend
Copyright supply
or demand triumphs. Typically, the
trend prior to the consolidation is
continued; however, there is always
the possibility of a reversal. (To
learn more, read Retracement Or
Reversal: Know The
Difference, Market Reversals And
How To Spot Them and Support And
Resistance Reversals.)
Beating a Breakout
Generally speaking, many traders
will wait for a base to be broken by
the stock trading above or below the
base before entering a position.
While this is a perfectly acceptable
trading style, traders can often
position themselves ahead of the
impending breakout by watching for
a partial retrace within the
established trading range. A partial
retrace is when a stock stops short
of an established high or low of a
trading range and then reverses
direction. Typically, this is an early
clue that either supply or demand is
being overwhelmed and that a break
out of the range may be imminent.
While there is more risk in terms of
failure rate, this risk is mitigated by
tighter stop losses and the potential
for greater return when correct. It is
important to note that risk
management is extremely important
in this type of trading because there
are no guarantees that the move out
of the base will be a continuation
one.

Trading a Partial Retrace

WPT Enterprises, Inc. had
established a trading range in late
2006 after a downtrend lasting
several months. Rather then making
lower lows and highs, WPTE started
trading to equal highs and lows,
effectively changing trends from
down to sideways. While
consolidations are typically resolved
as continuations of the prior trend,
WPTE looked like it might be
staging a reversal based on a major
downtrend line being broken (not
shown). After trading to the top of
the range in late October, WPTE
started to see buying well before
trading back to the bottom of the
range in mid November. Demand
began to outstrip supply, as WPTE
refused to honor the established
trading range. The candles (long-
legged dojis) show extreme
indecision, which suggests
confusion among market
participants. This indecision is
actually another clue that something
was happening, as the established
trend was for it to move lower, not
higher.

While there is no way of knowing

whether the stock is pausing or
reversing until after it happens, the
use of other tools in your technical
toolbox can provide areas likely to
provide support for a partial retrace.
Examples would be moving
averages, Fibonacci
sequences, Bollinger
Bands or gaps. A calculated risk
can be taken as long as tight risk
management is employed. Typically,
the second higher daily high after a
decline of several candles into such
support is enough to confirm your
thesis of a reversal. This would
place the buy at 3.85 for WPTE
with a stop about $0.10 lower. (For
more insight, check out Exploring
Oscillators And Indicators.)

Figure 3
Source: StockCharts.com
WPTE attempted to break out a
week later and was ultimately
rejected by the previous trading
range. Nonetheless, buying the
partial retrace netted a 15% gain in
a week. It should be noted that it's
not a bad idea to take profits at
resistance due to the increased risk
of buying in a base. As sellers were
waiting at this established resistance
area, excess supply began to force
WPTE to drift back into the trading
range after the failed breakout.
Buyers returned in late January and
early February at the same partial
retrace area established earlier.
While there were several false buy
signals, it started becoming clear
that WPTE was under accumulation
in late January. The buy was a little
over 3.80 again with a stop well
under the partial retrace at 3.54.

Figure 4
Source: StockCharts.com
WPTE rocketed past resistance
shortly thereafter, completing the
breakout. Once it cleared the trading
range, the trend changed to an
uptrend. Notice the higher pivot
highs and lows marked on the chart.
WPTE was up over 50% in four
weeks and it remained an open
trade.
 Figure 5
Source: StockCharts.com
Another Example
Qiao Xing Universal Telephone Inc.
offers another example of a partial
retrace. This time we are looking for
a partial retrace within a pullback,
rather than a lateral consolidation.
There is no hard rule for what the
base should look like, but the key is
to look for a subtle change in an
established range.

XING was making lower highs and

lows (marked by the red arrows)
throughout the latter part of 2006.
Things changed in early 2007 as
XING began making higher highs
and lows (shown by the green
arrows) after making a partial
retrace. It was a partial retrace
because it refused to make a lower
low, which was the established
trading range. Why were we looking
for a partial retrace in this area? If
you look toward the tail end of
December, you will notice a gap
higher that remained unfilled.
Typically, gaps hold as support
moving forward; this increased the
odds that XING would complete a
partial retrace in this area. XING
continued to move higher quickly
until it stumbled in late February.

Figure 6
Source: StockCharts.com
Summary
While there is much discretion to
trading partial retraces, once the eye
is trained to look for them, it can be
a fairly reliable pattern to trade.
While this type of trade may not
feel natural at first, this is how
professionals build positions every
day. By getting in before a breakout,
a trader can become the "smart
money" and unload his or her shares
to the usually late "retail" traders at
resistance areas and after the
breakout.