Pullbacks Trading Techniques

Pullbacks Trading

The entry technique I will present using pullbacks is based on the groundwork laid in the last chapter on swing-high and low violations. Although there is a near infinite number of ways that pullbacks can be used for trading, I will confine this chapter to one basic variation. That is not to say I don’t use other pullback techniques, or that I don’t consider other techniques to be worthwhile.

In fact, quite the contrary is true. It’s just that volumes could be written on pullbacks, and it would be outside the scope of this book to do more with the concept than I plan to. I have chosen one of my most commonly used pullback entry techniques for presentation. The technique I have chosen dovetails the best with the material presented thus far, and it is also incorporated into the ‘cool trick’ I will present in chapter 9.

As I implied at the end of chapter 6, the pullback technique I will present is just a way to anticipate, perhaps ‘jump the gun’, on the swing-high or low violation technique. I am simply going to take a guess, albeit an educated guess, as to when I think the pullback may end, and take the trade at that point. This will have the effect of getting me in earlier than the swing-high or low violation technique, but perhaps, too, getting me into a trade that may not play out as anticipated.

I generally use this technique when I have the setup for the swing-high or low violation in motion, and I get the feeling that the trade is really looking good to play out as I expect. This can be a subtle thing, such as how the buyers or sellers are acting, what the volume on each bar is looking like, how other indices and issues are behaving, how this issue looks on an even lower timeframe and a host of other things I watch. I can’t lay this out for you exactly; it’s a subtle, experience-based thing. But when I feel that the issue is about to explode and I’m running out of time, I frequently switch to this technique on the fly.

The setup, as I’m describing here, is the same as the setup from the last chapter. The key is to recognize a pullback that has the characteristics that you find acceptable. For me, as I mentioned, I want the pullback to start fairly soon, pullback at least 50% and have nice time symmetry.

The only real characteristic that I just described, as far as I’m concerned, that may be hard to decide on is how far the first thrusting move should be before the pullback starts. I can see on the chart, by eye, where the area is that I want the first move to go to. The question is, what characterizes that area, so that you can see it similar to the way I do? I’m not sure I can really qualify it for you, but I can give some hints to help guide you.

Ultimately, though, even if the hints are followed, it may still lead to some areas that I would look at and see right away that they are not what I would utilize. This is just recognition, gained from experience, and I can’t give that to you. Let’s go back and look at a few charts from the last chapter and critique them, looking for clues to my thinking process. We’ll start out with the mini 3-minute chart example from figure 6.5. See figure 7.1.

The first thing I would note here is that the first thrust is a bit on the small side. I would have preferred the first thrust to go a little further. Why do I think this? I’m looking for the first move to go more than what could amount to a small and simple pullback in the current trend. Pullbacks that are 3-5 bars are commonly jumped on, in this case from the buy side. A pullback that goes 5 bars or more starts leaning, in my opinion, towards being a greater correction, and starts to tip the scales more in favor of the potential turning point. I’m also looking for the first move to be proportional in size to other moves the issue has been making up to this point.

Generally, I’m not looking for the first move to be the size of the larger pullbacks to the trendline, but more like the first moves off of the trendline. Keep in mind, I say trendline here just as a guideline. Sometimes the issue doesn’t fit a trendline well. In this case I just look at the oscillations of the issue, and see the relative size of the various swings that it lays out. This gives me an idea in my mind of what I may be looking for. I look most closely at ‘first thrusts’ from the larger corrections. This is the approximate amount I am looking for on a new first thrust in the possible new trend.

In figure 7.1 I see what looks like a good candidate. See figure 7.2.

The first thrust up from where the arrow is on the chart looks to me to be an average first thrust move for the issue here. The move is 3.50 points. I also see two more first thrust moves that I could focus on. Let me add arrows to the chart for those two moves. See figure 7.3.

The first move on the left of the chart was 4.25 points, and the last move, on the far right of the chart, was 2.50 points. The average of the three moves is 3.42 points, or to the nearest tick, 3.50 points. That’s the exact value of the first thrust choice I made from figure 7.2, as looking like an average first thrust type move.

I picked it because it was in the middle of the values that I saw on the chart, and thus I expected that it would be a good representation. I didn’t do a lot of calculations to come up with that, you can just look at the chart and figure it out. Now where would 3.50 points put the termination of the first thrust down off the top? I’ll add that to the chart, to see where I would be looking for a first thrust to go. See figure 7.4.

The area for an ‘average’ first thrust would indeed be lower. For me, the area around 971.75 would have been a lot better of an area for the swing-low to form. Let me add back in the trendline, and we’ll see something quite interesting. See figure 7.5.

Note the proximity of the trendline to the labeled area of 971.75. I do not believe this is a coincidence. I find the first thrusts are frequently in or about the area of the trendline. Also notice how the area I was looking at around 971.75 is also at just about the same price level as the last swing-high before the final top. I also believe that that is not a coincidence. I frequently observe the first thrusts going to areas of previous swing-points like this.

Given all this information, why would I have still considered this a good candidate for a swing-low violation entry? There are several reasons. The most important thing to consider is that this is not a perfect world. You will rarely satisfy all the criteria you are looking for. So, at some point you make a judgment call based on experience.

I felt the trade setup, i.e., the potential trade area from the higher timeframe, was a very good setup. I liked the general behavior of the mini on the lower timeframe chart, as it approached the area. I also noted that I could have a tighter protective stop loss with the smaller initial thrust, since 1’d be closer to the potential trade area. Based on experience, I felt the swing-point was acceptable.

Let’s look again at the swing-high from figure 6.11. I observed that the first thrusts were approximately the same at this time as in the last example, about 3.50 points. I added the 3.50 points to the potential reversal point in the trade area, and labeled the chart with a line at 981.25. I also included the trendline that was used for the trendline violation technique. See figure 7.6.

It is clear to see, and again interesting to note, that the first thrust is very close to the expected first thrust and is ‘in or about’ the area of the trendline. I think this should provide enough additional information for the reader to be able to get a handle on the character of acceptable swing-points and pullbacks. To complete this phase I will reassess the example of the swing- point I didn’t accept as a candidate in the last chapter, as shown in figure 6.4. Let’s look at that chart again. See figure 7.7.

This was the swing that I felt was just too far from the potential trade area, and I accepted not taking the trade using this technique. I did mention that the area that looked good was perhaps just above the very small swing and pullback area (between the reversal point and the swing-high labeled on the chart), and that that smaller swing-high was just too quick off the bottom and didn’t pull back enough for me.

Let’s now put the trend line on the chart, and, since the first thrusts are still around 3.50 points at this time, I’ll also add the line for 3.50 points off the bottom. This shows me the area that I would normally be looking at. Keep in mind, I determined this 3.50 points as my own approximation as to how I felt the issue was trading at the times these charts were unfolding. I am in no way implying that the issue trades like this anymore, or that the 3.50 points was anything special.

In fact, the 3.50 points may not have been correct for anyone’s trading except my own, even at the time these charts actually unfolded. Each trader must determine for himself or herself what parameters may work for them. I say all this because it is critically important that all readers understand that I am using these examples to explain my thinking process, not to give details of how I think any particular issue should be traded. The examples are used only to show how I reason out my trading process.

Let’s move on to the chart. See figure 7.8.

This is quite interesting. It turns out that the smaller swing was right at the expected area for a first thrust (a coincidence?), and the swing-high labeled was, in fact, way too far from the potential trade area. But notice the trendline. Even the way too far up swing-high didn’t get to the trendline. What does that say?

When you first look at the trendline, as it is considered as a potential entry trigger, you must evaluate if it makes sense to consider its use. In this case just two points determine the trendline, and the second of those points comes after a significantly large countertrend move. This is going to have a large part of the price action well away from the trendline. This can be seen by the large air gap between the prices and the trendline between the contact points.

What this tells me is that I would be using a trendline that hasn’t been tested at all (no third or fourth contact point, etc.), and one that is going to be far from the potential trade area. Although either of these conditions doesn’t necessarily preclude the use of the trendline as a potential trigger, both together greatly decrease the utility of the trendline for me. Combine these two conditions with the fact that the trendline is way above the area where I would expect the first thrust move to go, and that would pretty much preclude my using it.

This is all interesting, but this is a discussion right now on the swing-points and pullbacks, so how does this relate to that topic? Well, I was saying that generally the first tradable swing-point and pullback frequently happens in or about the trendline area, and in this case that wasn’t even close to correct. This should be an alert to the trader. As I alluded to before, I will commonly put three or four techniques on my chart and see how they look as the potential trade develops.

This not only allows me to ‘shift on the fly’ with my choice of techniques (if I want to), but it also allows me to look for ‘anomalies’. I’m looking for anything that doesn’t fit, and in this case the trendline being so far from the preferred area for the first pullback to occur would get me ‘digging into’ the trade a bit more, looking to understand why that might be. Another thing I frequently notice, and I consider this one of my best-kept ‘secrets’ (until now, that is!) is that the first pullback will usually occur three to five bars after the crossover of a 5/15 period simple moving average.

This is not to say that a pullback always occurs, or always occurs in this area, just that when it does occur my experience is that it most often occurs in this area three to five bars after the crossover. This also helps me in my determination of the viability of a swing-point for use in the swing-point violation technique, as well as the viability of the subsequent pullback for the pullback entry technique. The lack of this criterion won’t preclude the move from my consideration, but it will be one of the factors I will use in my consideration.

At this point I feel I have given the reader a detailed look into my thought process for determining the relative attractiveness of a given pullback for use with the swing-point and pullback techniques. Using this information, with some experimentation and practice, each trader should be able to make an informed decision about potential candidates that meet their own personal criteria. All that is needed, now, is how I trigger a trade that has pulled back.

Like many of the techniques presented so far, there, of course, isn’t one clear-cut answer. I use several different triggers, depending on the individual situation. Each trader will have to decide if he or she finds benefit from my particular triggers, or if they want to formulate ones of their own.

I have three basic triggers that I use for most pullback entries. All are fairly simple and straightforward. To start with, I use a similar concept to not taking a trigger until the potential trade area is penetrated. In this case, the pullback must be at least 50%, and once it has reached that amount, I will then accept a trigger. I will first briefly present the three triggers, and then go into details and examples on them.

The first trigger is simply a fade entry once the minimum 50% retracement has occurred. The fade may be immediate or I may wait for a ‘slowdown’ or ‘pause’ in the action, and then enter. The second trigger is taking out the high of the last bar of the pullback, once it has reached the minimum 50% required retracement (reverse for short trades). The third trigger is the ‘cool trick’ entry I will present in chapter 9. If this one set up, it is my preferred method.

Let’s look at MSFT on a 15-minute chart. I found a very nice-looking potential trade area on the 60-minute chart, and I have dialed down to the 15-minute to look for an entry. The potential trade area is around $25.40. A pullback is starting and I’m waiting for the 50% retracement to be penetrated. See figure 7.9.

As soon as MSFT trades at $27.57 I would consider an entry trigger, assuming, of course, that this happens fairly soon and in an orderly manner. This goes without saying, but I’m mentioning it to make it clear that this is a here and now opportunity. The part I don’t mention on each and every example is that I’m assuming it continues its pullback and penetrates the area below the 50% retracement, and doesn’t do anything that I don’t like the looks of. If i t goes sideways, for example, for the next ten bars and then goes below the 50%, I will have abandoned the trade long before that point. Each trader needs to decide individually what is acceptable price action as potential trigger time nears, but it must always be considered.

Let’s advance one more bar and see what happens. See figure 7.10.

The trade would now be triggered on a fade entry. Although there is no way to know if an actual fill could have happened at $25.57, let’s use that price for the sake of the example. If I were in this trade my most likely stop placement would be just under the potential trade area (which is around $25.40). I can now also be looking for trigger entry type number two, above the top of this last bar. The last bar has a high of $25.66. Let’s add another bar and see if MSFT is going to trigger the second entry type, or if the first entry is going to take some ‘heat’. See figure 7.11.

The trade would now be triggered by the second method, trading over the high of the previous bar. For the example, let’s use the price of one cent over the high, so that would be $25.67. For the additional educational value, let’s note that the swing-high point is at $25.76. Using one cent over the high as the example price for the swing-high violation trigger, that trade would trigger at $25.77. So, you can see that the fade entry is $25.57, the trade over the bar high entry is at $25.67, and the swing-high violation entry is at $25.77.

It’s just a coincidence that the increment of increase in each case is ten cents. You can see how each entry costs you a bit more, but generally will give you a little bit more confirmation. But, just as before, you can also see that, in the context of the 60-minute traded timeframe, the differences are very small. I’ll add in quite a bit more data to this chart to show how this trade played out, to put the differences in the entry into context. See figure 7.12.

I will refer back to this example in chapter 9, when I cover the ‘cool trick’ entry. I wonder if the ‘cool trick’ will wind up giving an entry very similar to the current entries? I think you know the answer to that one.

Let’s look at one more example of a pullback entry and then move on to the next technique. Well look at UPS, using the swing-high and pullback from figure 6.15. I’ll start with the daily chart, showing the pullback as it is forming, with respect to the 50% retracement. See figure 7.13.

UPS hasn’t quite pulled back my minimum 50%, so I’m not ready to accept a trigger just yet. I’ll move one bar ahead and reassess. See figure 7.14.

UPS has now penetrated the 50% retracement minimum and has thrown a very strong reversal bar. This last bar opened at the low of the bar and closed at the high of the bar. A fade entry would be triggered at the trade below the 50% retracement line. For this example, let’s say that trigger price is $53.48. I would be looking, now, for a trade above this last bar, for a trigger of the ‘trade above the high of the previous bar’ entry. I’ll move one more bar ahead and see if UPS triggers. See figure 7.15.

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UPS blasted above that last bar, triggering not only the trade above the high of the bar entry, but also the swing-high violation, on the same bar. For the sake of this example, we’ll say the second entry trigger price is $53.90, and the swing-high violation entry trigger price is $54.98. The prices are all fairly close, again, given the price of UPS. You definitely trigger at a better price, though, by anticipating the swing-point violation with this technique. I will refer back to this example, also, when I present the ‘cool trick’ in chapter 9.

In the next chapter, I will revisit swing-point violations, but this time with a new twist. By adding this new twist, it will add many potential entry opportunities for trades. It will also address, at least partially, the problem of what to do if you simply don’t get any swing-points or pullbacks after the potential trade area is penetrated.