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How To Profit From Trading Pullbacks

By Hector in Trade Articles on 04 December 2019

How To Profit From Trading Pullbacks

What is a pullback?

 

A pullback is a price swing that is against the primary trend.  A pullback in an uptrend happens when price action goes down and then starts to move up again.  On the other hand, for a pullback in a downtrend, price will go up temporary and then starts to move down lower again. It is the retracement that is discussed  in this  article A Retracement or Reversal.

 

The pullback trading strategy is a profitable approach to trade in the direction of the primary trend. It is a basic trend following strategy that trades the path of least resistance. As you know, the trend is your friend and you want to make use of this strategy to profit from trading with the trend.

A pullback in an uptrend allows traders to buy on weakness at a lower price and sell higher.  Conversely, in a downtrend, a pullback will allow shorting opportunity at a higher price and buy back lower. With this approach, it gives you the opportunity  to reduce your risk while maximizing your profit.

 

Trading Pullbacks

 

Pullback Trading Strategy

 

There are many ways to trade the pullback. Here, we present a step-by-step guide  on how to trade the pullback with our price action trading.

 

Step 1: Identify a primary trend in the higher time frame

For the pullback strategy to work, it is important to identify a primary trend. This strategy may not be suitable for a stock that is not trending and trading in a small range. It is easier to identify the trend with the top down approach using a higher time frame such as the weekly chart.

In an uptrend, we are looking for a series of higher highs and higher lows.

In a downtrend , we are looking for a series of lower highs and lower lows.

Alternatively, we can use the exponential moving averages (EMA) to help us visualise the trend.

For example, in an uptrend, the 20 days EMA is above the 50 days EMA while in a downtrend, the 20 days EMA is below the 50 days EMA.

 

Step 2: Switch to the lower time frame

 

After identifying the trend and having a market bias to buy or sell, we’ll switch to a lower time frame chart like the daily chart to draw the support and resistance lines.

The support and resistance lines are the important swing pivots where the bulls and bears battle it out. It will determine whether the pullback is completed and the primary trend is going to resume or a reversal of the primary trend is going to happen.

 

Step 3: Identify the Pullback stage

 

Next, identify the minor trend which is against the primary trend. This is the pullback you have been waiting for.

If the primary trend is up, look for a counter trend that is going down.

If the primary trend is down, look for a counter trend that is going up.

 

Step 4: Price Action Setup in Pullback

 

As the pullback approaches near the support and resistance levels drawn, we’ll use price action setup to time your entry to buy or sell.

Specifically, you are looking for 2 reversal price action setup for entries:

  1. Bullish Pin Bar (PB+)   / Bearish Pin Bar (PB-)

  2. Bullish Engulfing (BE+)  / Bearish Engulfing (BE-)


                                                 


The price action of the above reversal candles on the chart send us alert that the pullback may be ending and give us the signal to enter and join the primary trend.

 

Step 5: Place the Protective Stop Loss

 

In any trade setup, it is important to know where is your stop loss level before you enter each trade. The support and resistance levels on the charts provide us with the protection to reduce the risk on our trade.

We can place our stop loss on the opposite side of the support or resistance level from our entry. A break of this level will invalidate the pullback trade and the protective stop, when triggered, will get us get out of the trade.

 

Step 6: Take Profit

The strategy to profit from a pullback trade is to place your profit target at the prior swing high (for buy) and swing low (for sell).

Alternatively, you may liquidate half the position at the prior swing high or low and let the other half to trail the profit if the primary trend continues.

Let’s use an example to show you the steps to take for a Pullback Trade strategy:

 

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Example of A Pullback Trade On POEMS Mercury

 

Step 1: Identify a primary trend in the higher time frame (Weekly)

 

Pullback Weekly Chart

 

Step 2: Switch to the lower time frame (Daily)

Step 3: Identify the Pullback stage

Step 4: Price Action Setup in Pullback

 

Pullback Daily Chart

 

Step 5: Place the Protective Stop Loss

Step 6: Take Profit

 

Pullback Setup

 

Advantages of a Pullback trade:

  1. The pullback trade strategy give us the advantage of buying at a lower price in an uptrend to reduce risk and the opportunity to ride the primary trend to increase profit.
  2. This strategy can be used for all time frames and the steps to take can be used for day trading, swing trading or position trading.

 

Conclusion

 

The pullback trading strategy is a profitable strategy in trading stocks or other assets which are trending. A trending market does not move in a straight line but move up or down in waves and traders can take advantage of the pullback to profit from it.

 

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Happy Trading!
One Good Trade

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