Trading on trend pullbacks
The beauty of a well thought out pullback trading system is that you enter the market or place your first trade only after confirming which way the market is going. Doing this is going to help you eliminate entering the market with a false signal, where the price of the Forex pair initially appears to be going in a particular direction, but then suddenly makes a sharp u-turn.
Download the short printable PDF version summarizing the key points of this lesson…. Click Here to Download Since currency pairs remain within a range bound or consolidation phase most of the time, and the market trends only about 20 percent to 30 percent of the time, finding an established trend to trade pullbacks in can be a challenging task.
How to Trade Breakouts & Pullbacks
As a Forex trader when you are trying to apply a pullback trading strategy, you need to act like a sniper. You need to wait, then wait some more, sometimes for hours — if not days — before pulling the trigger. Consequently, you need to make sure that you have identified the possible turning point, where the retracement move is likely to end. You need to find a way to generate a high probability pullback signal where the price is likely to resume the prevailing trend.
If you can successfully apply a pullback trading system, you can buy low during an uptrend and sell high during a downtrend. This means your stop trading on trend pullbacks could be much closer to your entry if you place the order during a pullback or retracement compared to placing the order when the price was moving in the direction of the trend.
So, in a nutshell, there are three basic steps that you need to take to successfully trade pullbacks within a trend: Identify an existing trend Identify potential reversal areas or market conditions where the retracement of the trend may resume the prevailing trend Apply a pullback trading strategy that offers high-quality trading signals to time your market entry so that you are executing a trade that offers a high reward to risk ratio.
Nevertheless, before we dive into discussing real world scenarios and examples, you should get familiar with the theoretical aspects of why trading pullbacks during a trending market work in the trading on trend pullbacks place.
What is a pullback?
Bulls and Bears sometimes have a unique interpretation of developing economic fundamentals, and they put their money behind their respective interpretations. When the majority of the market participants or even a few large institutional players believe the price should go up or down, this supply and demand imbalance can act to drive prices sharply higher or lower.
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- Our team at Trading Strategy Guides puts a lot of focus on trend direction.
- This simply means jumping into a market that has established a trend, and then has gone against that trend as markets typically do, forming an ebb and flow over time.
If you have ever watched Level II order flowyou can see how the price triggers each order as prices are moving up or down. Now, once the market starts pushing the price up or down, and establishes a trend, at some point, some traders would start taking profit off the table.
Pullback Definition and Example
They may be thinking that the price will not go much higher or lower, or they just simply want to secure some of their earned profit. Regardless of the motivation, these trading decisions can decrease the trend momentum, and as this happens we start to see pullbacks emerging in the market. Often, you would see that these pullbacks come close to a previous consolidation zone or pivot points on the chart.
Often these pullbacks test a prior Support and Resistance level. Since Forex traders know these levels have previously acted as pivot zones, a large amount of pending orders accumulate around these price levels. As a result, when a pullback of the trend reaches these price levels and if there were sufficient orders in the market in the direction of the trend, the market resumes the trend.
Otherwise, the support or resistance levels break, and a trading on trend pullbacks reversal may ensue in the market. Remember that while identifying a trend can be relatively easy using a naked chart or with the aid of a few technical studies, knowing if the trend is strong enough or gauging the probability of the trend to continue after a pullback is a bit more difficult to accomplish.
Having said that, it is quite doable if you apply the right technical analysis tools and have a comprehensive strategy to trading pullbacks. For most new traders, it is strongly recommended that at the beginning stage that they try to stick to trading pullbacks in a trend rather than engage in counter trend or mean reversion methods. The best aspects of trading pullbacks during an established trend is that even if the price of the Forex pair goes beyond your initial entry point, you will typically have a chance at re-entries.
Pullbacks in a strong trend – one of the most profitable trades
However, as you gain more experience trading pullbacks in the forex market, you can then move on to developing more sophisticated strategies to compliment your trend pullback strategy.
But again, if you are a newbie, then you would do best to start by focusing on picking the low-hanging fruit, which in this case is trading pullbacks during a trending market.
Pullbacks happen all the time and if you learn how to trade pullbacks, you can enhance your repertoire and find many more high probability trading scenarios. Pullbacks come in many different forms and in this article, I explain the five most common ones. You will also learn different pullback entry techniques. What is a pullback?
Click Here to Join Identify the Underlying Trend The first step towards learning how to trade pullbacks is to recognize a trend. If the price on the left of the chart is lower than it is on the right, and making higher highs and higher lows, then you are watching an uptrend in action.
On the other hand, if the price on the left of the chart is higher than it is on the right, and making lower highs and lower lows, then you are watching a downtrend.
It is that easy to identify an underlying trend in the market and something that all traders should be able to do rather trading on trend pullbacks.
You can also use two moving averages and confirm the trend when a crossover happens as well as use it as a confirmation of the pullback resuming the prevailing trend. However, there is a major shortcoming of using EMA crossovers for spotting a pullback or trigger a market entry.
If the pullback momentum is not that strong, like in the first instance in figure 2, the EMA crossover might never happen, and the trend may resume, leaving you wondering when to enter the market. Furthermore, an EMA crossover acts as a lagging indicator, and by the time it generates a signal, the market may have moved quite a bit in the direction of the prevailing trend. As a result, the reward to risk ratio of your trade may be decreased as well.
Hence, it would be much better that you try to identify a potential reversal area during a pullback and place your trades using more efficient price action based market entry methods.
A multitude of tools are available
Identify Potential Pullback Reversal Area One of the central tenets of technical analysis is the fact that old resistance turns into new support and old support turns into new resistance. By using this principle, you can quickly identify where the market may reverse during a pullback.
Once the price broke above this resistance level, the first pullback found strong support around this level. Often you would find that when you are trading pullbacks in a trend, these old support and resistance levels trading on trend pullbacks an excellent location to place your limit orders on the side of the prevailing trend.
In this instance, if you had placed a buy limit order a few pips above the old resistance, you would have aligned yourself in the direction of the breakout with an excellent reward trade binary options with 10 risk ratio, as the pullback did not penetrate below the pivot line.
Figure 4: Fibonacci Retracement Levels Can Act as Potential Pullback Reversal Zones Besides identifying an old support or resistance level for possible pullback reversal pointsyou can use another time-tested method. In this case I am referring to utilizing major Fibonacci retracement levels.