Learn What is PULLBACK and WHY It is Important For TRADING (price action basics)

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.