How to Trade the First Pullback
“Sometimes the best things are just right in front of you.”
Never forget the bigger picture when trading. It is important to keep track of how price is reacting to certain challenges in the market. Trading price action pullbacks, can be very profitable if done correctly. Learning to trade is a journey, once you built a solid foundation, the rest of the journey should be easier. The Financial Market is a common place where investors, buyers and sellers exchange their goods. Each market is governed by its own rules and regulation. Since each market has its own personality, it takes time and focus to understand it. Once you do that, you’ll be making enough money.
Market price never moves in a straight line, this is the truth. In fact, it is continuously cycling up and down. Each time price moves lower, buyers come into market as price becomes cheaper. On the other side, when price moves higher, sellers start to close their positions as they take profit. Some buyers who panic because prices are falling, they close their positions very quickly, so there are always reasons to cause prices to move up and down. An interesting fact that you must be aware of, is that it is difficult to predict how far price moves away before it is pulled towards the mean again.
A pullback is the falling back of a security’s price from its peak. These price movements might be seen as a brief reversal of the prevailing trend higher, signaling a temporary pause in upward momentum. A pullback happens when price moves at least one bar against the dominant trend direction. Pullbacks are sometimes referred to as Corrections. A simple pullback moves in three legs (Note: a leg is the journey traveled by the price in a single movement). Pullbacks can happen in different shapes, depths and speeds. Unless a trader understands how pullback work, it is nothing more than another price pattern.
That’s why traders instead of trying to predict the future it is more important to recognize these pullbacks and perform based on how these pullback behave. A simple pullback can endure simple or it can become a complex pullback as well. If it takes much of your time looking for simple pullbacks, it’s probably because they are complex ones,or, they are not pullbacks at all. If this happens you should simple ignore it and look for trading opportunities elsewhere.
There are different types of pullbacks and we are going to mention some of them:
• Deep pullbacks: the price moves a significant distance against the DTD (dominant trend direction). The dominant trend is the overarching trend that’s operating within the market at any time. Deep pullbacks can happen quickly or slowly.
• Shallow pullbacks: it moves very little against the DTD, a shallow pullback shows that the market is one-sided.
• Sharp pullbacks: it is a very quick pullback and the speed of it is the key identifier, it is typically made up of only one or two bars, but this doesn’t mean that it can not happen when you also have multiple bars. It can be considered as a deep pullback.
• Flat pullbacks: is is considered a shallow pullback. But it is more extreme because the market only moves sideways. A flat pullback is an indication of a very strong market.
Whenever you see a complex pullback you should stay out of the market. They happen when price steps into a consolidating phase, and no one knows how long it remains consolidated before it moves again. Trading is about trading when it feels right.
• Rising / Falling Wedge Pullback: occurs when you have a price action pullback that is slanting upwards when in downward trending market. As the wedge starts to narrow, shows that the market is becoming more indecisive.
• Rising / Falling Flag Pullback: it is very similar to Rising Falling Wedge with the exception that the price range stays consistent as price moves against the DTD.
• Sideway / Rectangles Pullback: is a sideway price movement.
• Double Bottom / Top Pullback: occurs when price retraces to the same price level twice before it resumes back into the DTD.
• Ascending / Descending Triangles Pullback: since price only moves towards the dominant trend directions the extremes are not retested, making it one of the most attractive patterns to trade.
• Widening Wedge Pullback: happens when the upper resistance line and the lower support line separate. It is one of the most complex pullbacks and it is where most new traders often get trapped.
There is a pullback in each price cycle and they happen in any market conditions. Reading price action using swing highs and lows is a great way for spotting pullbacks. In order for you to succeed using price action pullbacks in your trading, you need to know how pullbacks fail, so when it happens you are prepared for it. Some of the signs when a pullback fails are: market moves sideways, after that it continues in the original trend direction, then it reverses and starts a new trend in the opposite direction. One of the best thing about trading, is that the market is driven by humans, and humans are immune to changes especially at market extremes. Understanding the final test of extremes is to find out that buyers or sellers don’t give up easily. From all these information so far you already know that a pullback is a price action signal, which represents market and investor’s behavior.
Our objective as traders is not to predict the future, it is searching for clues in order to accumulate the probability of success in our favor. The more clues you find the more the pullback will work in your favor. If you find pullbacks reversing around 23.6% or 38.2% Fib ratio, shows that price can go much further, on the other hand if you find pullbacks reversing around 61.8% and 76.4% ratios, chances are higher that they can show weakness. The fact that there is strength in the market, makes smart buyers see the sharp pullback as a good buying opportunity to buy at cheap price before price climbs higher. The ability to understand time-frame correlation is probably one of the most important knowledge in any technical trading. In order to increase the chances of trading success in a trending market, you should look out for clues to increase the probability of success. These clues include:
• Shallow Pullbacks
• Trend Bars
• Price Channels
• Horizontal Support and Resistance level
• Knowing the market players and time-frame
There are different market players in the financial market and they have a different role to play in the market. The most important are:
• Big players: Central Banks or major financial institutions, they are long term market players and usually drive the markets as they have deep pockets.
• Mid players: usually are mid-sized or small-sized banks, market makers, large corporate or commercial companies. A mixture of short term and long term players, they are able to influence the small players.
• Small players: are retail and private individual traders, they don’t influence much the market. Understanding the market players can help you plan ahead, because of the fact that they are able to impact other market players. When you see a strong trend bar on the daily chart, think of following that same direction, because it is a good indication that the big players are in the market. Looking for the right market players can be challenging that’s why you need practice.
As a conclusion it is important to understand how market pullback work, when they do, and when they don’t. Once you start applying technical analysis and pullbacks and you are happy with your decision, that’s when you know that you are already in the journey towards technical mastery.
Hmm.
great post, very informative