PULLBACK TRADINGTrading on a pullback is one of the options for trading in Price Action patterns. Like trading on a breakout, this style implies the use of pending orders. Trading on a pullback is more popular than on a chart breakout. If Price Action signals are used correctly, it can bring more profit with less risks.
🔵 Characteristics of the strategy of trading on a pullback
This strategy, as well as all other trading strategies based on Price Action, is considered universal and multicurrency, suitable for any asset and timeframe. However, it is recommended to trade on liquid currency pairs, such as EURUSD or GBPUSD on hourly or four-hour charts. The daily D1 is also suitable for trading. When trading on a pullback, traders place limit orders (as opposed to a breakout, where stop orders are used).
🔵 The principle of trading on a pullback and the algorithm of placing orders
The basic idea of the strategy is that the price, before it goes in the necessary direction after the formation of the pattern, usually pulls back, and if you catch the moment trend continuation, you can enter the same trade on more favorable conditions, with a smaller stop-loss and larger take-profit.
Trading on a pullback is performed as follows:
1. A Price Action pattern appears on the chart. This can be a pattern of engulfing, a doji candle on a trend reversal, etc.;
2. At the opening of the next candle, a Limit pending order is placed (to buy, if an uptrend is expected, and to sell, if a downtrend is in progress). The order is placed approximately in the middle of the signal candle;
3. Stop Loss is set a few points beyond the extremum of the signal candlestick (below the minimum if trading to buy, above the maximum if trading to sell);
Take Profit is set at trader's discretion. As an alternative, you can multiply the value of a stop-loss by 3 or 4, or set the take profit at the next key level, so that the price is guaranteed to catch it when it reaches this level.
🔵 Example of pullback trading
As an example, we will consider trading on a pullback on the hourly chart of the EURUSD in detail. As an alternative, we will also consider the variant of opening a breakout order in this situation and compare the results.
Events have developed as follows:
1. After a bullish move, a bearish doji candle was formed, signaling at least a correction;
2. At the opening of the next candle a Sell Limit order was placed (in this case the order was opened at the market, since the price at that moment was at the level of the supposed pending order);
3. Stop Loss is set above the maximum of the signal candle, Take Profit - in the area of the nearest support level;
4. The stop loss ratio is approximately 1:2.5, which provides a positive mathematical expectation of the trade;
5. After 6 hours the deal closed in profit.
In this case both trades would be profitable, but profit on breakout of the support level would be almost twice less, and the stop/stop profit ratio would be 1,5:1 not in favor of take profit, which is considered inappropriate from the money management viewpoint.
🔵 Additional details of pullback trading
Despite the fact that, in the example above, trading on a pullback was more profitable than trading on a breakout, it cannot be argued that this style is absolutely better. There are drawbacks to trading on a pullback as well. Unlike trading on a breakout which can be applied to all possible Price Action patterns, limit trading is not possible in every situation. Due to this the number of signals and possible transactions is reduced, and therefore the potential profit will also be less. In spite of the fact that as a rule the take profit at breakthrough trading is less than at limit trading. As we have more trades during the same test period, trading on the breakout can bring more profit.
For example, the screenshot above shows the trend continuation pattern of an inside bar. When trading on the breakout, a pending order is placed above the maximum of the parent bullish candle which opens after several hours and the trend goes upwards, bringing profit to the trader. There are no reasons for the limit trade in this situation.
It is impossible to place a pending order in the middle of the inside bar, and there is no logical reason to place it in the middle of the mother candle.
It happens that the signal not to open a trade on a pullback on the limit order does not work, even when there are all the conditions for it. For example, during the formation of an engulfing pattern on the screen above placing a limit order in the middle of this pattern was quite logical.
However, the signal candle turned out to be too strong, the pullback movement has not reached the pending order placed and the trade was not opened. In the same situation when trading on the breakout the trade would have been opened on the next candle, and in a few hours the trader would have fixed the profit.
🔵 Conclusion
Trading by Price Action on a pullback has both advantages and disadvantages. On the one hand, this style allows you to make more profits with less risk in the same situation, when trading on the pullback shows less attractive dynamics. On the other hand, not all price action patterns are suitable for this style, in addition even suitable signals sometimes do not work, leaving the trader without profit.
The choice of trading style largely depends on the trader's temperament. The pullback method suits the patient and conservative traders who are willing to wait for the signal for days and even weeks. As a result, such waiting will be rewarded with high profits on each of trades. More aggressive traders would be better suited to trading on the breakout which allows them to enter the market more often compensating the small profit and probable losses with the number of profitable trades.
