Pullbacks- When trends take tea break


Pullback

It is hard to predict when a trend will begin or end precisely. But it is comparatively easy to ride an already known trend. Drawing from our discussion on the Core Price Pattern, we saw how the Impulse-Retracement-Impulse pattern shows up when the price moves. Pullbacks take advantage of this tendency. Thus they have a high likelihood of showing up and be “less random” than usual.

A requirement for pullbacks is that markets should be trending, that the price before the pullback should be in a clear uptrend or downtrend. Pullbacks come in all intensities and sizes, below is an ideal schematic.

Good pullback opportunities often come from recent impulse moves. Momentum oscillators would register a fresh local high ( example: MACD, etc.).

Entries to take trade depends upon the conviction. A conservative approach would be to trade when the price crosses the upper channel. An aggressive approach would be to enter when the price bounces from the lower channel. Many times this lower channel would be too steep to be even present.

We can even use a Moving Average to determine the entry (although not always applicable) whenever the price bounces off it. (My personal go-to is a collection of 20 and 50-period Exponential Moving Average)

We want to exit the trade when the price moves against our position. But determining the optimal stop loss can be tricky. There are multiple methods at disposal: Fixed percentage stop, Volatility-adjusted stop, and level-based stop. I will recommend leaving some extra space so that your stop losses are not so tight.

What move to expect after a pullback? Well, that is complicated and uncertain. Two factors dictate the outcome: 1) strength of the parent trend and 2) Retracement of the pullback. Conservative target would be to book as much as the price had retraced during the pullback. The aggressive target would be to eye movement similar to the previous leg of the trend. You can also indicators to “indicate” about when to exit, we will study those possibilities separately. Smaller targets are easier, and bigger targets get rarer.

What can go wrong? A pullback can turn into a reversal, or the trend can go limping into a range. For reversal, the price would go against your trade direction, hitting your stop loss. For range, it just wouldn’t go in your direction and will keep on fluctuating. You can also set a time limit for your trade to play out, if it doesn’t, then you can exit.

Reminding you again that the Pullback is as good as its parent trend. Parent trend should show some recognizable signs of strength. These signs can be big candles, gaps, the slope of the trend, and the absence of strong counter-trend price moves. Conversely, a mature trend that has sustained many such pullback-laden legs, would get increasingly infertile for a fresh pullback to occur. Mature trends also exhibit some signs of exhaustion, we will study them in the Trend Reversals Chapter.