What is a Pullback?
A pullback is a brief retracement of a stock from a recent spike or rally. If the demand is strong, the pull back is short-lived and aggressive buying pushes the price back up to continue its rally.
Pullbacks, for the most part, are buying opportunities in a strong uptrending market. It is also the market's way of 'resting'. As aggressive institutional buying pushes the price up, the price eventually hits overbought levels and encounters some degree of profit taking. If the selling is moderate and demand is still strong, buyers will start to come back in at key support levels and push the price even higher. This 'big push and small pull' movement creates the ladderized uptrend that have become a classic pattern of a bullish market.
When market conditions are healthy and institutional buying is strong, pullbacks will provide good entry points to ride the next upswing. However, not all pullbacks tend to move the same way. There are variations to look out for depending on how price action behaves.
To illustrate, here are some pullback entry strategies to help you out:
Pullback Trade Strategies
There are various ways traders can enter a pullback. Generally, you want to have a support level that will act as a potential bounce point for the ongoing pullback. If buying pressure builds near the support, the price will bounce and will continue its rally. The point where the price bounces from the support level is your buy signal.
Here's 3 basic ways to illustrate this:
1. Pullback to Dynamic Support
Dynamic supports are Moving Average (MA) lines that move with the support as it continues to rally. When the price pulls back, a common bounce point of strong momentum setups is the EMA9 (green line in the picture below). EMA9 is generally regarded as a momentum support indicator. Strong rallies usually bounce at this level and continue to climb and pullback over time.
In the chart above, the EMA9 line acts as a dynamic bounce point for each pullback. You basically want to enter as the price bounces from support (in this case, EMA9). As a risk management precaution, set a tight cutloss point from the dynamic support level should it breakdown.
2. Pullback to Static Support
Pullbacks to static support levels are illustrated as a bounce from horizontal plotted support lines. This is done by connecting troughs and peaks of past prices to form a clear support level. The more points of connections, the stronger the support level is. If the connection occurs on multiple years, the support level is deemed as a 'key support level'.
In the chart above, the price action shows a ladderized rally where the price consolidates and breaks out multiple times. At each breakout, the previous resistance of the past consolidation acts as a static support level which serves as a bounce point for higher base consolidations. This forms a sustainable rally wherein a healthy amount of buying and selling is exchanged at every consolidation. Strong demand pushes it for a breakout and the cycle repeats.
To enter this setup, you want to be buying as the price bounces from the static support level. Afterwhich, you monitor if the price can sustainably breakout from resistance. If it does, you adjust you stop loss level as new support levels are created.
3. Pullback to Trend line Support
A pullback to trendline support is illustrated as a price bounce from a clearly plotted trend line support. During strong uptrends, price will often create an ascending channel. To flesh out the ascending channel in the chart, connect the troughs and peaks of the uptrend to reveal the trend line support and trend line resistance.
In the chart above, the price rally encounters brief pullbacks after several days of climbing. At each pullback, a bounce point is created. After two or more of these, a channel can be plotted to show that the price is sustainably moving to and from this ascending channel pattern.
To enter this setup, you need to buy as the price bounces from the trend line support. As the price climbs back up, you can either choose to sell at a medium term profit taking level or you can also choose to buy and sell the multiple swings of each pullback to score quick gains.
We hope you loved our posts! To learn more about trade and investment, access the Online Learning section of our website to enjoy our free Learning Module.
Comments