When the price of a financial instrument starts trending, it is a matter of time for the price to experience some pullbacks. These pullbacks are not a reversion of the general trend but normal and necessary retracements as the price reaches levels of resistance that it needs to break to advance toward new prices.
We could say that pullbacks are necessary because they go to lower prices where the demand begins increasing again as it offers better opportunities to traders, and new orders enter the market, seizing cheaper prices for a new momentum movement towards resistance levels beyond the previous swing.
Identifying A Pullback
Spotting a pullback can be a difficult task if traders do not have enough information. Traders need to analyze the chart and understand the market structure to determine if there are continuous swings according to the direction the price is heading to.
Uptrends or downtrends can be identified as follows:
- If the price is forming lower lows and lower highs, then the market is downtrending.
- Otherwise, if the price is making higher highs and higher lows, then the asset is trending up.
After identifying the lows and highs in the market structure, traders can draw a trendline connecting every retracement represented by the lower highs and higher lows. It is crucial to connect these retracements as they represent the opportunities for a pullback entry.
Source: Pullback Trading Strategy: Identifying Pullbacks!
Entry and Exit Points
Once traders identify a trending market and, by drawing a trendline, connect at least two retracements, they will be ready to seize an entry opportunity in the next potential pullback.
To seize the next pullback, traders need to:
- Identify a resistance in the previous swing and beyond it, an area like an order block in the past where the price is likely to retrace from.
- Wait for price action around the resistance area, looking for a candlestick pattern such as an evening star, which could be a signal for the pullback to begin.
To determine precise entry and exit points, traders can implement the following techniques:
- Price Action with Technical Tools: Traders can combine price action with tools like the Fibonacci retracements, including the trend line, to add weight to signals like an engulfing candle. A price action pattern emerging over a 0.618 fibs retracement can be an excellent entry point.
- Technical Indicators: By using technical indicators such as MACD and RSI, traders can measure the strength of the price or spot divergences to confirm an entry point. For instance, MACD crossovers might anticipate a pullback at the beginning and give signals at the end for trend continuations.
To target exit points:
- Traders can use the Fibonacci extensions
- The distance between the resistance and the pullback end can be measured and used to spot targets beyond the previous swing.
Source: Pullback Trading Strategy: Entry and Exit Points!
Conclusion
Pullbacks represent opportunities in a trending market to capitalize on that trend. This type of movement differs from reversions as they recover rapidly offering new entry points at cheaper prices.
A pullback is affected by supply and demand forces and that can be measured by technical indicators like RSI and MACD.