What is pullback trading, and why does it work? Pullback trading in essence is what you’re trying to do is to buy the dips, buy the retracement by the correction in an existing trade. For example, if the Forex market is trending higher you are looking to buy the dip, the retracement. That is why it is called pullback trading.
Why does it work?
The reason why this works is that when the market is trending it doesn’t go up in one straight line like people just go up. Instead, in an uptrend, you can expect to see a series of higher highs and higher lows. As a pullback trader, you’re trying to do is to time your entry and the retracement on the correction.
How do you trade a pullback?
- Existing trend;
- Area of value;
- Entry trigger;
- Take profit;
At first, we are trading pullbacks, so first and foremost trade in the direction of the trend to identify an existing trend and then we can look to trade pullbacks in it.
Number two, we want to identify the area of value. Here’s the thing just because the market is in an uptrend does not mean we want to blindly hit the buy button because we want to be trading from an area of value. An area of value could be things like a swing low it could be supported, a trend line, a trend channel. This is a potential area on your chart, where buying pressure could step in.
Third thing, since we are trading pullback the next question is where do we set our stop loss. So if you’re trading pullback then your stop-loss should be below the lows of the pullback. This means if the market rallies higher and it breaks below the lows of the pullback it clearly tells you that this pullback has failed and you want to get off the trade.
A very simple way is to identify the lows of the pullback then give it some buffer below the lows. You can use the ATR indicator for it. The low of the pullback is a hundred dollars, and you pull out the ATR indicator. The average true range of the market is five dollars so what you can do is just take a hundred dollars which is the low of the pullback minus five dollars and your stop-loss is about ninety-five dollars.
The last thing is where do you take profits.
If you are trading in the direction of the trend you can reference the extreme swing high to take profit. As you know, when you are trading pullback you’re buying the dip when the market has retraced against you. When you retrace against you and look prior to the retracement you should be able to identify a swing high on the chart so that swing high could be a reference point for you to take profit. If you are looking to buy the pullback, the long market has moved in your direction you can take profits just before the swing high.
Why not after the swing high or why not at the absolute swing height? It is because swing high swing low support resistance and that they are not a specific level on your chart, they are an area on your chart. This means that the price could come close to the swing high but not reach the exact price point and then start to reverse from. There it’s possible because you’re dealing with an area on your chart.
So if you don’t want to watch your open profits come close to your target only to watch the market do a sudden reversal and hit your stop loss, then what you want to do is to set your target just before the recent swing high. For you to know to take profits off that area on the chart makes sense. Want to know more? Read more of my articles or watch on the channel.