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Catching The Pullback Trade
Catching The Pullback Trade
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For the long-term trader a pullback can create the opportunity to buy low, and sell higher or to sell high and buy lower.
But as many traders soon learn, pullbacks can be a killing-ground that trap the unwary on the wrong side of the trend and
Trends and pullbacks go hand in hand with one another. As sentiment swings back and forth from optimism to pessimism,
so does the direction of price. This can often result in the market overshooting or undershooting. It is these places that
To identify a pullback, we first need to know where the average trend is and how the market is reacting at that instant in
time.
For example, in a strong bullish trend the price will typically rally to a new high, test the resistance and then fall as
course some use the top as an opportunity to sell out. This is the lifecycle of a short term pullback.
A simple strategy like this requires nothing more than a moving average, and the Bollinger band filter.
First, place the Bollinger band indicator on to the chart and choose a period and deviation so that all but the extreme
points are inside the bands. A period of about 20 chart bars and 2 deviations is usually a good point to start.
The center line of the Bollinger indicator will now show the moving average of the trend. The bands and the center line
These examples are of course historical but from them we can identify the characteristics of a pullback/continuation
The first thing to confirm is that the market is trending in a certain direction rather than ranging. Figure 1 shows a segment
of the EUR/USD daily chart. In this date range, the trend turns from bearish and then to bullish.
The price breaks new lows or highs and touches the outer Bollinger band
At reversal the price crosses back to the center line, the moving average
In a bearish trend, the pullback high doesn’t reach above the last one
In a bullish trend, the pullback low doesn’t reach below the last one
Most pullbacks tend to be short and sharp with a clearly defined reversal point.
If a pullback extends in a broader correction then we give this more caution. If it breaks higher or lower than the last
reversal that is a sure sign that the trend may be reversing. In the EUR/USD chart, we can see this happening at the black
vertical arrow where the trend turns from bearish to bullish. This is the reversal point.
From the direction of the moving average line, we confirm that downwards momentum is slowing here already before the
reversal starts. The MACD divergence confirms this before the pullback begins – Figure 2. Going short here on
The most common strategy for trading pullbacks is to go in the direction of the trend. Here we time the entry to maximize
For a swing trader, entry and exit timing as well as fill price is everything on trading the pullback. Get this wrong and the
profit can easily turn the other way and become a loss. For a trend follower, this timing is not so critical.
Only enter the trade when there is clear enough evidence that the pullback is completing. This usually requires at least
two or three bars at the reversal point that are moving in the direction of the trade.
A simple way to do this is by creating a stop order with your broker. The timing of the order and the stop price is set to
Otherwise, the stop order expires unfilled. Expiration occurs if the pullback extends further and does not reverse within the
timeframe specified. This happens for example, in Figure 1 at the third bearish pullback.
Stop losses
In a bullish trend, the price action is likely to bunch in the top half of the Bollinger band. In a bearish trend, it bunches in
the lower half. We can use this pattern in deciding stop losses.
If the price extends for any time into the opposite territory of the Bollinger band to which you are trading, it is usually best
to close out.
A good stop distance is roughly half way between the entry price and the opposite band level to which you are trading. For
example if we sell to open in the third bearish pullback in the chart above at 1.0540, the stop would be around about
1.0640. For a short sell, the profit target is the bottom of the band, in this case around the 1.0315 mark.
As with any trading strategy, using other confirmations helps to decide between pullbacks that could lead to a quick profit
One way to confirm a pullback is by using known technical patterns. Most pattern types are either continuation or reversal.
not always present but when they are, they can offer valuable insight into the state of the market.
The downside is that waiting for confirmation patterns does delay entry into the trade. In addition, due to the randomness
of markets, there is no confirmation that will be accurate one hundred percent of the time.