Trading The Pullback

The Pullback is one of the most reliable trading signals, and it is used in trading various chart patterns. In this article we will define the pullback, address its advantages in trading and show examples of its use.

Definition
Pullback occurs after a breakout of a certain psychological level, when price returns to the level it previous broke. If price bounces from that level, it is said that price 'pulled back' to the level. The psychological level can be a Support level, a Resistance or even a dynamic level (trendline).

The Pullback is a very strong trading signal, due to several reasons:

1. Confirmation of Trend - The breakout prior to the pullback confirms that price is in a strong trend, that is capable of breakout psychological levels. This empowers our trade and gives us extra-confirmation which, if we traded the breakout itself, we would not have. This way we trade pattern but give resepect to the prevailing trend - and combine swing trading with trend trading.
2. Logical Stop Loss - When trading pullback, we know exactly where to place the stop loss, contrary to the breakout in which we do not have a logical stop loss position. Our stop loss is also smaller when trading pullbacks. This improvement in stop loss can result in much higher risk:reward ratio, better profitability and smoother equity curve. Even the smallest decrease in your stop loss size can have an astounding effect on your balance.
3. Chart Pattern is Confirmed - If we trade the breakout itself, it is possible that the chart pattern was misidentified and is actually too weak to trade. However, if we wait and confirm a breakout, the chart pattern is confirmed beyond any doubt and we have a much reliable signal.

Illustration

Examples of Pullbacks

Fig. 1: Pullback to Resistance trendline of an Ascending Channel

Fig. 2: Pullback to Resistance trendline of an Ascending Channel

Fig. 3: Pullback to Horizontal Support level

Fig. 4: Pullback to Resistance trendline of an Asymmetric Megaphone


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