A Pullback: Trade Against a Trend
Reading analytical outlooks on the price movements, you might be met with the word “pullback”. Many trading strategies are based on a pullback action. Pullbacks allow you to trade against the trend.
Do you think that it’s wrong as the theory teaches you to follow the primary trend? What is a pullback actually? Keep reading to learn about tricky pullbacks.
If you are familiar with a price chart, you know that an asset never goes straight. It moves up and down even within trends. Look at the image below. We have a strong uptrend. Every time the price goes down, it’s a pullback.
A pullback is a short-term price movement against the primary trend.
You should already be able to catch the pullback meaning from the explanation above. Simply stated, a pullback is a movement against the primary trend for a short period of time.
Triggers of Pullbacks
We can say that a pullback is a pause of the primary trend. It means that bulls in a downtrend and bears in an uptrend take control over the price for a while. There can be several reasons why the price changes its direction. To predict a pullback, you should learn about fundamental analysis.
Pullbacks occur due to a change in market sentiment.
- Speaking of Forex, there can be news that signals a weakness of the base currency. Economic events mentioned in a calendar also affect the strength of currencies.
- If you trade metals, you should pay attention to the news. The overall market sentiment has an impact on their price.
- Choosing oil, you should follow the news that defines the market sentiment as oil is a risky asset. Also, crude oil inventories data influences the commodity’s value.
- If you are experienced enough, you can try pullback stock trading. Earnings reports, internal company’s events and industry news affect the price movement.
Pullbacks: Real Examples
To predict pullbacks, you should know how to analyze price movements. Let’s consider a real example of a pullback.
Pullbacks occur not only on currency charts, but on the chart of any financial asset. Consider an example of a pullback stock trading. It’s a four-hour chart of Apple stocks. As you can see a pullback may also happen in the downtrend. Moreover, during a pullback candlesticks can break above resistance or below support, but later return.
Pullbacks: Benefits and Drawbacks
A pullback is a complicated pattern that has more disadvantages, especially for a beginner trader.
Better conditions. A pullback allows traders to buy at a lower price in an uptrend and sell at a higher price during a downtrend.
Imagine you couldn’t catch the beginning of the uptrend but still would like to enter the market. The price moves up in the upward trend; thus, every time the peak is formed, your chances to buy at an appropriate price reduces.
However, when a pullback happens, you get an opportunity to get a lower price.
Pullback or reversal? It’s not easy to determine whether it’s a pullback or a reversal, especially for newbies in the Forex market.
Imagine you thought the market turned down for a short-term and kept your trade open expecting the trend will continue.
However, it was a trend reversal, and you suffered significant losses.
Difficult to predict. It’s hard to predict the beginning of the pullback and its end. You can easily miss the point when the trend resumes.
Pullback vs. Throwback
Pullback and throwback often confuse traders. These terms are interchangeable.
According to one theory, a pullback occurs when a price breaks a support line upside-down for a short period of time. After the price goes back, in this case, support becomes resistance. A throwback is a situation when a price breaks the resistance bottom-up, but returns. At the same time, resistance becomes support.
It seems that a pullback is supposed to happen in uptrends, and a throwback occurs in downtrends. Still, many traders call both occasions a pullback.
Pullback vs. Reversal
Beginner traders may be confused when dealing with a pullback and a reversal. An example will clarify the difference.
As you can see, a pullback (1) is a short-term price reversal. A real reversal (2) reflects a longer-term change in the trend. A reversal happens when market sentiment changes. It can be tricky to differ one term from another. That’s why you better use trading indicators that will help you define the trend.
Top Indicators for a Pullback Trading
Many indicators can separate a pullback from a reversal. We will mention the most effective. Later you can use other instruments. Still, to find the right ones, we recommend using indicators that determine support and resistance levels and demonstrate divergence.
Trend technical indicators help traders distinguish pullbacks from reversals.
The moving average indicator has many functions. One of them is to signal a market reversal. Here, you should learn more about Golden and Death Crosses. When a moving average with a smaller period crosses an MA with an immense period bottom-up, it’s a signal of the uptrend. When an MA with a more extended period is crossed from top to bottom, it’s a sign of a downtrend. Although, in many cases, the lag of the MA indicator is considered a disadvantage, in this case, it’s a big pro that will ensure the trader is about to see the trend reversal.
Pivot Points is one of the best indicators that help to define support and resistance levels. The price is supposed to pull back from these levels. Thus, if the price touches this level, you can consider it as an entry point on the pullback. If the price crosses the levels, it’s a reversal.
Fibonacci retracements also serve as support and resistance levels. Thus, you can use them to define pullbacks. Usually, 50% and 61.8% levels are used in trading strategies. If the price rebounds from these levels, it’s a signal of the trend continuation. Here, you can use buy or sell limit orders.
The RSI oscillator is used to define overbought and oversold market conditions. If the indicator crosses the 70 line upside-down, it may be a sign of a pullback. When it breaks the 30 level from bottom to top, it can be a pullback as well. However, the more reliable signal is a convergence/divergence. When the indicator forms a divergence with a price chart, it’s a signal of the price reversal. It can be both a pullback and a trend reversal. Here, you should consider market sentiment.
The ADX indicator doesn’t show the direction of the trend but reflects its strength. Any reading above 25 signals a strong trend. Thus, you can easily define whether it’s a pullback or a reversal. If you see that the reading is above 25, a price reversal can be considered a pullback. As soon as the ADX moves below 25, expect a trend reversal.
Top Pullback Trading Strategies
As we have said, it may be hard to determine a pullback on the chart. If you have never dealt with pullbacks, we offer you several trading strategies that will allow you to practice pullback trading with limited losses.
The first strategy is based on trendlines. All you need to do is draw a trendline. If it’s a bullish trend, you should draw a support line. If it’s a bearish trend, you need to put a resistance line. This line will serve as a barrier. If the price breaks this level, it’s likely there is a trend reversal. However, if the price rebounds, it’s a pullback.
Moving Average Strategy
Here, we will combine a moving average and a candlestick pattern. If you are familiar with candle patterns, it won’t be difficult for you.
You should apply a moving average on the price chart. It will reflect the current trend and work as a support or resistance. The period of MA will depend on the timeframe you trade on.
As soon as the price touches the MA, you should look for a reversal candlestick pattern. The best options are Engulfing and shooting (on the chart below) or evening star patterns. Thus, it’s a great option to buy at the lowest price or sell at the highest one.
ADX is another indicator that can help you to trade pullbacks. ADX doesn’t show the trend direction. It’s used to show the strength of the trend. Usually, any reading above 25 is a sign of a strong trend.
We should also implement the MA indicator on the price chart. The period of the moving average depends on the timeframe. As soon as the price touches the MA, and the ADX signals a strong trend, you can use it as an entry point and continue trading within the trend.
To conclude, a pullback is a confusing point in trading. It’s hard to predict it and distinguish it from a trend reversal. That’s why it’s crucial to practice pullback trading before entering the real market. You can use a Libertex demo account that includes a full range of trading instruments: from currencies to CFD.
CFD is an attractive option that allows you to trade stocks, metals, and oil; just by opening a trading account. Also, you can use all the indicators we mentioned above and open trades on pullback without risks for your funds.
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What is a pullback? It’s time to sum up our knowledge.
What is a Pullback in Trading?
A pullback is a short-term price reversal against the primary trend.
Will There Be a Pullback in the Stock Market?
It doesn’t matter what markets you trade; pullbacks are an essential part of the trading.
How Do You Identify a Pullback?
You can identify a pullback by simply looking at the price chart. Also, you can implement technical indicators, such as Moving Average, ADX, and RSI that will help you to distinguish a pullback from a reversal.
How Do You Predict Pullbacks?
You should follow economic events and news that may cause market fluctuations and a change in the force of market players (bulls/bears).
How Do You Trade a Pullback?
Pullbacks allow you to enter the market at a better price. Wait for a pullback to occur, find a confirmation from the candlestick patterns and technical indicators and enter the market.
Why Do Pullbacks Happen?
Pullbacks happen due to market events that cause a short-term depreciation of the traded asset in a bullish trend or appreciation of the security in a downtrend.