A pullback is where prices move against the trend. Market moves in waves and learning how to read and ride the market`s wave is a trader`s job. Using pullbacks can help forex traders find profitable trading opportunities with low risk. Also understanding pullbacks will help extend your profitable trades.
The below USDJPY weekly chart shows two major pullbacks against the uptrend.
Profitable forex trading is about choosing the right time to enter the market rather than predicting the future. If you predict the market correctly but your timing is poor you stop loss order could be hit before your target.
Too many traders enter a trend too late and make losses. A sharply rising can look like it could rise forever and the fear of missing out can result in poor trading decisions. Entering after a trade too late is worse than entering a trade too early as the losses will likely be greater.
There are three major methods to find pullback entry points
1. Moving average
In a strong uptrend the moving will be pointing higher and provide support. Wait until prices return to the moving average and start rising again to buy. In a strong uptrend short term moving averages between 5 to 25 bars will provide better entry points than long term moving averages greater than 30 bars. In long term trends a 50, 100 or 200 bar moving average can be beneficial to find pullback entry points.
2. Trend line
Through connecting lows from the rise higher an upward sloping trend line will be formed. Should prices return to the trend and rise then there is a pullback buying opportunity. Deciding which lows to use is a subjective choice and differs from trader to trader.
3. Previous highs
In an uptrend previous highs can act as support. Traders who sold at previous highs in an uptrend will be happy to buy back their losing positions should the market return close to their selling point.
My personal preference is to use a moving average as it is less subjective than a trend line and many other traders use a moving average. My setting will be a 10 bar moving average as I am looking to ride short term trends. Previous highs in conjunction with a moving average can be a powerful strategy.
Pullback risk management
Trend trading strategies can have win loss ratios below 50% so risk management is important. Aim to achieve an average profit of at least double your stop loss (risk reward ratio of 2 or higher)
Trends can continue for a long time and it is hard to predict how far the market could rise. If there are previous highs acting as resistance that can be a good point to exit if the market falls from resistance.
Alternatively you can place no target and use a trailing stop which moves higher as the price rises. A trailing stop can be beneficial where there is no resistance on the charts and the trend is strong.
Stops should be placed below the nearest support level which could be a moving average, trend line or previous high depending on your strategy. Exiting losses quickly can be difficult when the trend looks strong but remember you can always buy the market again should the market rise back above support. Having a strong confidence in an uptrend can lead to dangerous trading if you do not exit your loss.
Pullback mental control
Waiting for a pullback can be difficult for some traders as they focus on the fear of missing out on a potential profit. Thinking about the potential loss instead of potential profit can help you become patient for a pullback. Remember previous trades when you made a loss from chasing the market.
Accepting you can not predict the market can reduce your stress levels. The start of a new trend can happen very quickly and it is hard to predict. Remember it is more important to find high risk reward entry points than follow every trend.
The difference between a pullback and reversal
A pullback will start rising again when prices return to support whereas a reversal is where support is broken and the market is likely to move sideways to lower. A reversal can see prices move sharply lower so be prepared to exit your position when support is broken.