A pullback refers to a temporary reversal in the price of an asset after a period of upward or downward movement. If you’ve ever heard of “correction” or “retracement,” these are just other terms used to describe pullbacks.
The following strategies can form the basis of a solid stock pullback strategy, but their uses aren’t limited to just stocks. You can use them while forex trading or in the commodities and crypto* markets. Just note that pullback trading will be most effective in trending markets and less so in ranges.
🔸Strategy #1: Moving Average Pullback Strategy
Using the principle of mean reversion, we can start putting it into practice with moving averages. Moving averages often provide ideal areas of dynamic support and resistance and are a versatile tool in any pullback trader’s arsenal.
Requirements: You can use a simple moving average (SMA) or an exponential moving average (EMA), which gives more weight to recent prices. It may be a good idea to try experimenting with both to see which one you prefer.
Traders often use a 21, 50, or 200-period moving average, so again, you can try experimenting to find the most suitable one for you.
🔸Strategy #2: Fibonacci Retracement Pullback Strategy
Using Fibonacci retracements is also a common way to find entries in pullbacks. Recall that the price will often cross above or below 50% of the retracement. Sometimes, it’ll reverse to the key Fibonacci levels of 0.618 and 0.786 in a larger bull trend or 0.382 and 0.236 in a bear trend. Don’t forget that 0.5 itself is a Fibonacci level.
🔸Strategy #3: Breakout Strategy
Finally, in markets where the overwhelming trend is too strong to allow for a deeper pullback, you may try to trade the breakout. In a bullish breakout, for example, the price might quickly back up to test the resistance-turned-support before shooting higher. Note that some breakouts are merely false breaks designed to trap traders and force prices into a deeper retracement - just look at the significant highs in the first picture in this article.
To counteract these traps, you can look for high volume on the movement that caused the break, as well as the close of the candle. Candlestick patterns, such as shooting stars and hammers, can typically signal false breaks.
It’s also worth remembering that any pullback can signify a market reversal. Always be cautious and use these pullback strategies in conjunction with other forms of technical analysis before considering making a trade.
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