Last updated on April 22nd, 2020
Trading pullbacks is a time tested way of zeroing in on locations to trade. Whether you are using support and resistance, trend lines, moving averages, or even Fibonacci retracements, trading pullbacks is a viable part of trading setups that you can use.
Pullback trading is based on the natural ebb and flow price action of any trading instrument. Whether you are day trading or swing trading, it is a sound approach and one that fits one of two major things that a market does:
- Markets have a tendency to mean revert
- Markets have a tendency to consolidate
Pullback trading zeros in on the mean reversion tendency so by using pullbacks as part of a trading strategy, traders are utilizing the mechanics of a market.
But what if a market doesn’t pull back to your desired trading location?
You Need Another Transition Approach To Trading
There will be times that a market that is trending won’t retrace far enough to come into your trading setups zone and you need a way to deal with that certainty.
Imagine that you are a swing/position trader and you are using Fibonacci to measure the retracement of a corrective move. In this example, we have an impulse move to the upside which gives us an overall uptrend. You want to position yourself in that trend.
Since markets can pull back into impulse legs a certain percentage (you don’t need use rigid Fibonacci numbers – 25-75%) you zone in on a certain price point on the chart.
In our trading example, you can see your pullback did not come into your trading zone and the dark red box shows how much more room you needed to fill.
Price did not even retrace far enough to test the new price structure resistance area in the same location (we like to call the confluence in your trades)
If you only traded the one approach – trading price retracements – you missed getting on board this trade. Traders, when they miss a trade like this, have a tendency to toss out their trading plans and just market it so they don’t “miss out”.
That is the wrong approach.
Transitions You Can Use For Trading
There are two ways we will look at the will allow you to not only have your pullback zone of opportunity in place but also position yourself so you don’t miss trades like that.
Use A Consolidation Approach
Remember the two things that markets do? They revert to the mean and consolidate. It is the consolidation that we are going to look for.
When a market consolidates, to resume the trend we need price to break out of the range. Breakout trading carries its own inherent risks but as I mentioned in a post about failure test trading, you can position before the breakout occurs.
Let’s look back at the previous chart to see how we could have positioned long in this market. It doesn’t matter if you are swing trading for bigger gains or day trading for income, this concept applies to any approach.
This is a shallow pullback in terms of the overall length of the full impulse swing. We have a price pattern that we can use to get positioned in this uptrend when price transitions from consolidation to trending price action.
- Price has formed clear tops and bottoms in this horizontal range. Traders will position upon a breakout of this range but they have the higher pivot before the range to concern themselves with. You can see price did have a slight rejection at resistance prior to the big break. Traders may have considered that a failed test of resistance and exited their position when price closed back below the pivot resistance.
- Price action shows tests of low and were quickly regained two very obvious times. Astute traders could position inside the range at the close or break of highs of those failure test candlesticks. Traders that do so, as we may have seen evident by that larger momentum candlesticks, were well in profit before the ultimate resistance test occurred.
We did not need to see a full retracement to get involved in this uptrend. We did not miss the move which could have resulted in a trading plan breakdown as “missing the move” became more important than following your trading strategy.
This consolidation pattern is not hard to spot and as long as the resistance levels (in an uptrend) or the support levels (in an downtrend) are well defined, you have a viable means of entering the trend.
The most important part of this trading pattern is to see some type of testing of lows (or highs in a downtrend) as it will give you an objective entry and a defined risk point.
Use A Standard Trend Line Break
I am always cautious with trend lines as we can often see them break but price gets soundly rejected at the horizontal levels. Regardless, trend lines are a useful trading tool that can be used multiple ways in your trading.
I chose a sloppy trend line example to show that nothing is ever perfect in trading. There are a few ways in this example that you can have joined in on this downtrend if your pullback did not come into your trading zone.
- Once we are able to draw our support trend line, we can simply copy that to the upside for our resistance line.
- Price breaks the trend line and as mentioned earlier, horizontal levels can wield their power and this caused price to retrace.
- We have a test of the broken trend line (support to resistance) and then price drops with momentum to the downside.
While you may opt to not trade the initial breaks, the power of this comes with being able to judge the break of the trend line and add to the probability of a break of the horizontal lines.
Use Chart Patterns To Help Your Trade Entry
A strong break may have you getting positioned before the break using some micro chart pattern. In our example above, the break is strong in comparison to the other candlesticks. We also have a falling three candlestick pattern that is a continuation pattern.
Traders may opt to use pending orders below the lows of the 3 small bullish candlesticks to position before the momentum thrust.
Transition Trading Forms Part Of Your Trading Plan
You should see that you don’t have to be a pullback trader OR breakout trader. You can use both of these transitional chart patterns in one trading plan to ensure that every playable move in your instruments offer you the potential to participate.
It takes work and these are not stand alone trading plans. You still need to test these but also ensure:
- You have risk protocols in place for every trade you make
- You must know where you will get out if you are wrong – and you will be – on a trade.
- Profits only come when you exit your trade so ensure you know exactly how you will take profits.