A pullback trading strategy is a technique that is used by many traders to enter into a trade after security has experienced a sharp move higher or lower.
The strategy is based on the belief that after a sharp move, the security will “pull back” or retrace a portion of that move before resuming its original trend.
Many traders will use technical indicators, such as support and resistance levels, to help them identify potential pullback trades.
If the trend is your friend, the trader is more likely to succeed when you go with the market’s flow instead of fighting it. Nonetheless, purchasing breakout stocks or those undergoing an abrupt upward price movement would be against another bit of old sage advice – buy low, sell high – even when the trend unreservedly supports further increase. So what’s a trader to do? First, They ought to consider an alternative – the Pullback Trading Strategy.
What is Pullback Trading Strategy?
As per the name, a pullback is a stock’s short-term move in the direction opposite to that of the longer-term trend. This could be your chance to join an uptrend at a comparatively beneficial price.
- First of all, however, you will have to decide if the price drop is a pullback instead of an outright reversal. Determinants to discern when you are out scouting for pullback stocks:
- Volume – you are looking for a drop in the trading volume when the price pulls back. However, if the price picks up instead, the implication would be that sellers are gaining power and that the price will keep plunging;
- News -make doubly sure that earning or other noteworthy news is not imminent. Such like announcements precipitate a dip ;
- Support – examine the happening of the few preceding trading days. You would be looking for proof that the stock pulled back to a logical level of support, akin to an old low or a moving average, where buyers are potentially going to like the price. A stock that plummets below these levels is at increased risk of plummeting continuing.
The trade would like to be certain that the stock continues its uptrend or starts trading above the preceding day’s high, prior to you making your move. Waiting for the stock to achieve that mark yet again can go in the trader’s favor.
Trading a pullback stock
Provided these conditions are present, the time has arrived to enter the trade. You might want to mull two approaches:
- In case you are periodically scrutinizing the market, you can well buy the stock at its market price soon as it goes beyond the prior day’s high;
- In case you are not periodically surveilling the market, you might consider placing a stop-limit order. For instance, let’s suppose you are interested in purchasing a stock with the preceding day’s high of $37.50. You could place an order to purchase shares at a $37.60 stop, and a $37.85 limit. If the stock opens lower than $37.60, you will come into possession of the shares until it reaches said number. Moreover, if the stock opens high relative to your limit, you will likely have shares at a price that could eventually be profitable.
When to exit a pullback trade
To keep trending higher, a stock has to make ever-higher lows sling the way. Hence, when the price plunges below the prior low settled for during the pullback, there’s a greater likelihood of the uptrend has been over. Placing a stop order to sell the stock a tad bit under the current pullback low is a commendable way to paring down your downside.
In case the stock continues its uptrend, you will usually have two targets: the first is the preceding high prior to the pullback – old highs are frequently thought of as a ceiling that the market is loath to breach.
- At this point, it is a commendable idea to sell part of your position in an attempt to acquisition a minor profit, subsequently raising your stop to your initial entry point on the remainder;
- The second is grounded upon a measured move covering the distance between the most recent low and the most recent high before the current pullback, adding the said amount to the current pullback low.
The target price ought to, by rights, grab for you a nifty profit. The conditionality, naturally, would be the stock continuing its uptrend.
Following a pullback trade:
- 1. Observe for volume to decline during pullback;
- 2. Observe for the price to pull back to moving average (red line);
- 3. Enter when the price goes beyond the preceding day’ high;
- 4. Under pullback low, set stop order;
- 5. Set first price target to old high;
- 6. To the preceding measured move, set the second price target.
You do not have to exit your full position at that second target. You want to minimize your losses while maximizing your gains. You ought to be ready to grab hold of an even more momentous move.
Pullback Trading Strategy merits
Pullback trading is more akin to art rather than to science. Stock screeners just might help. These could identify candidates that have pulled back to their 20-day moving average, for example. In any case, a pullback trading strategy may be a great strategy for starting out. Researching and executing trades, you will gain the experience to ride the waves.
Pullback Trading Strategy: A practical instance with swing trading
Swing trading accepts technical analysis patterns. Patterns repeat in diverse time frames. The difference is in the manner in which swing traders use and interpret common patterns. Trend following pullback trading strategy is much more compatible with swing trading relative to that for position trading.
A pullback is just a consolidation within a trend. Consolidation patterns include pennants and flags. Swing traders use daily charts and intraday charts to identify the dominant short-term trend and any pullback patterns inside the trend.
They attempt to enter a position when a targeted stock’s prie stops plunging or pulling back. Hence, they can well capture the next move higher in the trend.
Once you have identified a trending stock and discover a pennant or flag pullback pattern by scrutinizing the daily charts, you have to try and enter position just as the pullback is ending. The classic setup is concerned with discovering an orderly pullback wherein each bar’s high on a pullback chart is lower relative to the previous one.
- You enter a position by placing a buy-stop order with your broker. Buy stop is very similar to a stop order. When the price is nudged, order execution takes place. Entering a position to trade pullbacks being an iterative process, you ought to use a day order rather than a GTC order. Following steps are essential: opt for your buy stop price, so it’s merely above the high intraday price shown in the chart’s last bar; were the stock price to trade above your buy stop price, your order would be executed. Conversely, at the EOD, the order stands canceled; provided you are still into this trade, adjust your buy stop price to a tad bit above the intraday high the most recent chart bar.
- You can then reenter your order; once your order is filled, place a stop-loss order utilizing a stop loss a tad bit below the intraday low of the lowest bar in the chart pullback;
- So long as the trade is active, keep adjusting the stop price to be just a tad bit below the intraday low of the chart’s most recent bar.
The price chart shows National Oilwell Varco, Inc stock exhibiting a strong. Several pullback trading strategies also appear on the chart.
The first pullback took place after the NOV trade to a new high of $30.44 on January 23, 2007. The new high appears as Bar#1 on the chart. Post pullback identification, you start the iterative process of setting the buy stop rice just above the high of the chart’s last bar.
At each EOD, the buy stop price is reset. It is yet again set a tad bit above the last bar’s high, and the order can be reentered.
IN this instance, Bar#2 sees trade triggered, which took place on January 30. You had to set the buy price a tad bit above the January 29 high ($29.44). NOV opened at $28.90 on January 30. The trade was triggered following the stock climbing above $29.45, climbing as high as $30.01 prior to receding and closing at $29.80.
You could realistically expect your order to fil close to your $29.45 buy stop price. In this instance, the fill price would be $29.50.
Post-trade execution, you set a stop-loss order below the previous bar low, $28.74in this instance. Alternatively, you may set the low at $28.90, the low of the trade ay. Either approach could be sensible – the decision is yours. Then, each day of the trade remaining active, reset the order a tad bit below the previous bar’s low on the chart.
For ten trading days, the trend’s thrust lasted. Finally, the position nudged the stop price on February 12, marked Bar#3, when the stock traded below $33.03.
The next chance to trade a pullback took place during the pullback that started after NOV traded at a new high on February 13, marked Bar#4. Finally, triggered on February 21, the trade was shown as Bar #5, when NOV traded high relative to the high of $33.85 of February 20.
The position nudges its stop price on February 27, shown as Bar #6, the stock trading below $34.91, February 28’s low. Considering slippage and transaction costs, the trade was little better than a breakeven trade.
The following opportunity came after the poorly formed pullback that started with Bar #6. You as the trader, entered the trade on Bar#7 when NOV traded above $35.00, the February 28 intraday high. Later, the trade would stop out two bars for a loss.
On April 26, 2012, NOV traded at $66.32. Therefore, for a swing trader, there were many trading opportunities using this stock between 2009 and 2013.
The theory behind trading pullbacks: How each Pullback Trading Strategy makes sense
What does trading with them tend to entail? It may sound indistinct to the inexperienced or novice trader. What we are looking for more specific guiding lights than adages like ‘the trand is you friend till it ends’.
90% of a seasoned trader’s trades are with the underlying market bias. He seldom tries to pick tops and bottoms. Nevertheless, this is not to say that the trader does not trade against the direction of the market. For instance, the seasoned trader may see a long-term uptrend in Crude Oil, subsequently waiting for the market to plummet before he rushes in and buys the market. This trader has faith in the underlying trend.
Rather than entering at the extended part of a move, there’s higher probability play waiting for a pullback and trading from it. Pullbacks help lower entry point risk since we are generally trading at a key market area or value area that has previously exhibited support/resistance. Key levels are vital containment points. The tide tends to shift at these inflection points very swiftly, causing large moves in the opposite direction, favoring our trade.
Trading pullbacks can be very profitable. Markets ebb and flow, wane and wax, and pull back assists you in refining your entry point, permitting you to enter at or near the turning; point between the ebb and flow. This is different from top/bottom picking, given that we are not trying to forecast a trend change. It would be hard to attain precision here. The approximate is close at hand if you are sticking with the underlying trend or trading courtesy of a key chart level. Pullback Trading Strategies will teach you great trading habits, like discipline and patience. It will help you to make profits with massive rewards.
Various quality brokers provide educational material for beginners without charging a penny. One of them is ETFinance. ETFinance is a reliable broker which provides its clients commission-free trading with a minimum deposit. The broker serves its clients with diverse financial instruments and commission-free trading.
1. Can pullbacks to key levels result in big risk-reward potential?
Trading pullbacks may also help in creating high-risk to reward plays. It is fairly common to pick up trades exceeding a risk-reward ratio of 5:1.
2. Is it possible to obtain 50% retraces even on intraday charts?
You can use the Fibonacci retracement tool to search for close to 50% retracement of moves, and it is possible to get in close to that 50% level.
3. How are key chart levels of support and resistance, and moving averages useful for pullback trades?
It is easy to spot support and resistance levels, observe them for a price, and pull back to them. then you can either enter right in or wait for a price action confirmation signal. ‘Fading’ is the recent market direction into the level.
Is it relatively easy to identify the most recent swing move and trade early retracement?
It takes a few weeks before it becomes apparent that a protracted pullback can keep moving lower. In such cases, we can search for upside retraces to sell or to get short. After the first retrace gets turned lower again, we are again looking to sell on the following retraces.