Retracements

From what I have read in trading books, there are a few stages in the whole trading  cum investment process. First is Money Management, then Position Sizing & Risk Mgt, followed by Entering, then Exiting.

Retracement is a concept from Technical analysis. It means that a stock might experience sharp rise in price then drop down some, then continue up again. The ups and downs form a W-shape but the general trend is still upwards. In the case of a falling stock. It goes down sharply, then goes up some, then continue downwards again in a M-shape with the general trend downwards.

It is one of indicators used during Entering or Exiting a trade. By itself it is not as useful but as a basket of indicators, it can help you decide when to go in (buy) or come out (sell) or buy some more (scaling in) or sell partial (scaling out). 

Say a stock counter you were eyeing had suddenly experienced a large increase in its share price (and you feel like you have missed the chance to hop on), there might be a chance to hop-on during the retracement.

The explanation for why there are retracements is psychological. Reason is that when price rose sharply, those who have missed the train want in and those who are on the train want out. So at certain price points, the rising stock price falls back down as those who want out sell to those who want in. There is selling pressure until it reaches a level where buying pressure overcomes selling, the price starts to rise again.

Similarly when the stock price falls sharply, those who are in want out and those who thinks its cheap enough to enter want in. So at first selling pressure is strong, then as those who are buying increase, the prices rises somewhat to a level when selling pressure is greater and overcomes the buying pressure, then overall the price starts to drop again.

But this retracement doesnt apply to all prices rise and falls. Just a falling price of a stock is not enough for you to go in. There are many reasons for it to fall. If the stock is falling cos it's business is not doing well, there is no reason to apply retracement to go in. Instead, one should avoid that stock altogether. There is no reason to even consider that.

Yet for those which are falling without fundamental reason - example investor irrational fear, and a good stock counter is suddenly sold down. Then there is reason to use retracement to find a point for you to enter or exit.

I shall use the example of KepCorp for illustration purpose. *The author shall not be held liable for any losses incurred if any reader went ahead and bought KepCorp after reading this.*

KepCorp fell drastically upon the news of the falling oil price and the low oil price affected the orders of oil rigs which is one of the core biz of KepCorp. However in recent days, with the news of the stabilizing oil prices and perhaps more optimism to rising oil prices, it started zooming up from as low as $4.74 range to $6.20 within a short period. Then it started falling back a bit.

Retracement calculation:

$6.20 (max reached)   -   $4.74  (the low that the rise started from)  =   $1.47

one-third retracement            =     $1.47   /   3          =  $0.49
so a one-third 33% price is   =    $6.20   -   $0.49   =   $5.71

This is a 33% retracement from the high of $6.20. So if you had missed the initial ride from ($4.74 up to $6.20), you can get on at this, provided other indicators look positive and you believe the price of KepCorp will continue to rise further.

Are there other levels of retracement? Yes, the one-third, half, two-third retracement. Different numbers are possible but there are roots to these numbers
known as the Fibonacci numbers. Useful numbers that seem to repeat in nature and also in charts. Hence it is possible to reach 50% retracement but that has implications.

50% retracement                        =   $ 1.47    /      2         =  $0.735
so a 50% retracement price is    =   $6.20   -    $0.735   =   $5.47

It can be used for a falling stock, just that the retracement amount is subtracted from the lowered stock price, to get the new low possible.

This is a useful start. Use other indicators to research before you click the buy button. Many say that it is easy to enter but not easy to exit the market. So this can also be one of the indicators to help you make the decision where and when to exit.