Learn What is PULLBACK and WHY It is Important For TRADING (price action basics)
In the today's post, we will discuss the essential element of price action trading - a pullback.
There are two types of a price action leg of a move: impulse leg and pullback.
Impulse leg is a strong bullish/bearish movement that determines the market sentiment and trend.
While a pullback is the movement WITHIN the impulse.
The impulse leg has the level of its high and the level of its low.
If the impulse leg is bearish, a pullback initiates from its low and should complete strictly BELOW its high.
If the impulse leg is bullish, a pullback movement starts from its high and should end ABOVE its low.
Simply put, a pullback is a correctional movement within the impulse.
It occurs when the market becomes overbought/oversold after a strong movement in a bullish/bearish trend.
Here is the example of pullback on EURJPY pair.
The market is trading in a strong bullish trend. After a completion of each bullish impulse, the market retraces and completes the correctional movements strictly within the ranges of the impulses.
Here are 3 main reasons why pullbacks are important:
1. Trend confirmation
If the price keeps forming pullbacks after bullish impulses, it confirms that the market is in a bullish bearish trend.
While, a formation of pullbacks after bearish legs confirms that the market is trading in a downtrend.
Here is the example how bearish impulses and pullbacks confirm a healthy bearish trend on WTI Crude Oil.
2. Entry points
Pullbacks provide safe entry points for perfect trend-following opportunities.
Traders can look for pullbacks to key support/resistances, trend lines, moving averages or Fibonacci levels, etc. for shorting/buying the market.
Take a look how a simple rising trend line could be applied for trend-following trading on EURNZD.
3. Risk management
By waiting for a pullback, traders can get better reward to risk ratio for their trades as they can set tighter stop loss and bigger take profit.
Take a look at these 2 trades on Bitcoin. On the left, a trader took a trade immediately after a breakout, while on the right, one opened a trade on a pullback.
Patience gave a pullback trader much better reward to risk ration with the same target and take profit level as a breakout trader.
Pullback is a temporary correction that often occurs after a significant movement. Remember that pullbacks do not guarantee the trend continuation and can easily turn into reversal moves. However, a combination of pullback and other technical tools and techniques can provide great trading opportunities.
