Bouncing Off Support/Resistance when Trading with the Five-Energy Methodology - dummies

Bouncing Off Support/Resistance when Trading with the Five-Energy Methodology

By Barry Burns

Some traders prefer to buy and sell retraces in the trend. Some traders prefer to enter trades on breakouts — entering the market after price breaks above a previous high (or below a previous low if trading short).

Entering on retraces or breakouts are both valid trading techniques. The concept of trading a breakout is to wait for the market to make a commitment to the upside by moving above a previous high.

When trading retracements, you enter at a lower price and your initial risk on the trade is smaller than the initial risk breakout traders generally have.

Breakout traders often criticize retracement traders by saying that we’re trading while the market is going against the trend, and therefore it’s more risky than their approach. They contest that no one knows how low the retracement will go before, or even if, the market continues in the direction of the trend.

Therefore, they believe that trading only when the market has proven it will continue in the direction of an uptrend, making a higher high, is more conservative and reliable.

That argument has some merit. But the fact that the market makes a higher high doesn’t guarantee that it will continue to move up after you enter the trade. Anyone who has traded for a long period of time can tell you many, many sad stories of false breakouts.

The figure illustrates a retrace to a Fibonacci level after which the market moves back up in the direction of the trend.

[Credit: Figure by Barry Burns]
Credit: Figure by Barry Burns