A retest is a common phenomenon in trading that occurs after the price breaks out of a support or resistance level. Understanding why retests happen can help traders anticipate price movements and make informed decisions. This article explores the mechanics of retests and their significance in trading strategies.
What Is a Retest?
A retest refers to the price returning to the breakout level after it has broken through a significant support or resistance zone. For instance:
- After a breakout above resistance: The price may return to test the former resistance, which now acts as support.
- After a breakdown below support: The price may return to test the former support, which now acts as resistance.
Reasons Why Retests Happen
1. Market Psychology
Trader behavior is a major factor behind retests. When a breakout occurs, some traders may doubt its validity and wait for confirmation. As a result:
- Buyers may enter after the price returns to the breakout level, driving the price higher.
- Sellers may exit their positions, providing liquidity for the next price movement.
2. Profit-Taking
After a breakout, short-term traders and scalpers may take profits, causing the price to pull back. This temporary selling pressure can create a retest before the price resumes its trend.
3. Testing the Strength of the Level
The market often “tests” the breakout level to confirm whether it has truly shifted from resistance to support or vice versa. If the level holds, it reinforces its strength, giving traders more confidence in the breakout’s direction.
4. Market Liquidity
Retests can occur as the market seeks liquidity. Many orders, such as stop-losses and pending orders, are often placed near breakout levels. A retest allows these orders to be executed, creating the liquidity needed for further price movement.
5. False Breakout Traps
Sometimes, a breakout may initially fail, leading to a retest. This can be caused by false breakouts or manipulative price movements aimed at trapping traders. A successful retest helps differentiate between a true breakout and a false one.
How to Trade Retests
Trading retests effectively requires patience and confirmation. Here’s a step-by-step guide:
1. Wait for the Retest
Do not enter a trade immediately after a breakout. Wait for the price to return to the breakout level and observe how it reacts.
2. Look for Confirmation
Use price action signals such as candlestick patterns (e.g., pin bars, engulfing candles) or technical indicators to confirm the retest. For example:
- A bullish candlestick pattern at the retest level suggests a continuation of the upward trend.
- A bearish pattern indicates the possibility of a reversal.
3. Set Risk Management Parameters
When trading retests, ensure proper risk management by setting stop-loss orders below the breakout level (for long positions) or above it (for short positions). This protects your capital in case the level fails to hold.
4. Use Volume Analysis
Observe the volume during the retest. A strong breakout followed by a low-volume retest increases the likelihood of the level holding.
5. Align with the Trend
Always trade retests in the direction of the prevailing trend. Retests against the trend are less reliable and carry higher risks.
Common Mistakes to Avoid
- Entering Too Early: Many traders enter before the retest is complete, increasing the risk of false breakouts.
- Ignoring Confirmation: Failing to wait for price action signals can lead to premature or unprofitable trades.
- Overlooking Risk Management: Neglecting stop-loss placement can result in significant losses if the retest level fails.
Conclusion
Retests are a natural part of market dynamics and offer valuable trading opportunities when approached correctly. They occur due to market psychology, liquidity needs, and the validation of key price levels. By understanding why retests happen and incorporating them into your trading strategy, you can enhance your decision-making process and improve your trading results.