There’s something emotionally comforting about trading pullbacks. After all, it’s human nature to want to buy things up on the cheap.
When I first began trading, it was easier for me to buy after declines rather than breakouts to new highs.
My first attempts at pullbacks involved indicators.
Generic things like placing market orders at oversold levels on RSI, MACD or stochastics.
But trading like this is not without problems.
In this post, I’ll show you the simple way I now enter the market on a pullback.
It’s my second favourite strategy, after the inside bar.
Oversold levels and market orders
Let me first though tell you why for leveraged traders market orders are not suitable – simply there isn’t enough precision.
What do I mean?
Bog standard strategies involve the trader buying at oversold extremes, or at levels such as fibs, moving averages, or support.
The idea behind being that at these levels price will miraculously bounce.
Sometimes they do, but many times they don’t.
Having blind faith that price will respect a certain level on a chart, is faith I cannot muster.
When prices are falling it means momentum is to the downside.
All too often market buy orders capture continuing downside momentum – leaving the trader to catch a falling knife.
When you use buy stop orders you have a natural defence mechanism (provided you know where to put it of course)
If you use a buy stop order you catch a market’s momentum as it turns positive.
And when positive protective stops can be moved up quicker.
This is vital – none of us wishes to experience 1R losses more than is absolutely necessary.
So when trading pullbacks you need a trigger line.
Here is my three-step process for trading them.
Step one – descending red bars
The first step is, the market you’re following has at least two descending red bars.
Meaning, the most recently closed bar must be red, and the previous bar must also be red.
In the chart of natural gas, circled you can see two red bars.
Note the second bar has a lower high and lower low than the one before.
Step two – moving averages
The 10-day moving average is the only tool I use other than price action.
It fits well with my short-term trading style.
Step two of trading pullbacks involves either:
- the most recent bar closing above the moving average
- the most recent bar closing below the moving average but tagging it.
In the chart above of natural gas, the whole red bar is above the average.
In the chart below of copper, the bar has closed below the average – but the high of the bar is tagging it.
I talked about tagging the simple moving average in my last post here.
Step three – the final hurdle
If step one and step two are complete, move to step three.
This is placing a buy stop entry order two pips or points above the high of the latest red bar.
This acts as the resistance to be cleared, or simply as I like to call it, the trigger line.
The order is placed – and is given one whole day to be filled.
Do this with a GTD order.
If after one day the order hasn’t been filled, it’s no longer valid.
This is important, and I discussed it here.
If a trade is going to work it’s going to work immediately. The longer you wait, the less potent it becomes.
Trading pullbacks trading rules
- The latest bar needs to be a red bar
- The previous bar needs to be a red bar
- The latest bar needs a lower high and a lower low than the previous bar
- If the latest bar closes below the SMA it must tag it
- Place a buy stop order two pips above the high of the latest bar
- Place a stop at the low of the latest bar
- If not triggered within one bar cancel the order
When to exit
As with all my simple trading systems, you move trailing stops to the low of each consecutively higher price bar – until stopped out.
I have commented on this before in the post here.
Why I like this system
Every market has it’s own personality. Some systems work well on one market, poor on others.
Over the years I’ve racked my brains and spent hours upon hours testing systems that worked across all markets.
Most of my research has proved fruitless.
But this system for trading pullbacks works well across them all.
And this pattern can be found regularly too.
For these two reasons, trading pullbacks is my second favourite strategy and one worth checking out for yourself.