Trading the Pullback in Forex and Stocks

One of the most profitable signal based on price-action and chart patterns is the Pullback. It is the highest accuracy signal that has an amazing win rate, sometimes even up to 90%. In this article you will learn what is the pullback and how to trade pullbacks successfully.

What is a Pullback

When trading chart patterns, most traders wait for a certain trend line to break and enter when it is broken, usually when price is closed beyond it, they enter a trade in the direction of the breakout. This is breakout trading and can yield good signals (mostly in Stocks and less in Forex).

After the breakout, price sometimes goes back to ‘test’ the level it has just broken. When price tests this level and bounces back in the direction of the breakout, it is said that price pulled back to the level. This is when the pullback occurs and when you can enter to take an extraordinary higher win rate than the breakout trade.

Examples of pullbacks:

The advantages of this signal are various:

1. Accurate Signal: While the breakout signal is a bit subjective, one trader can identify a breakout while the other may claim that price did not break the level yet, pullbacks are objective and very accurate. Once price pulls back and creates a candlestick reversal pattern it is certain that this signal occurred and you should enter the trade.

2. Small Stop Loss: Because price tests the level and immediately bounces back, the stop loss can be placed right near the local up\down swing so the stop loss is very tight. This helps us to get a very good risk:reward ratio unmatched by breakout traders.

3. Higher Win Rate: Pullback signal usually has much higher win rate than the breakout so your trades are more accurate and losses less frequent.
A single disadvantage of this signal is that trades are less frequent: not every breakout leads to a pullback and sometimes price breaks the pattern and reaches the target, not giving pullback traders an opportunity to enter.

How to Trade the Pullback

The way to trade this signal is to:
1. Wait for price to come close to a trend line (or any support\resistance level) it has broken.
2. Enter the trade when price shows a candlestick reversal pattern.
3. Place stop loss right above the highest high of last 3 bars (for short trades) and below the lowest low of last 3 bars (for long trades).
4. Calculate the risk:reward by dividing the potential profit by the stop loss size. If it is above 1.5, enter the trade.

Examples:

Note that generally we won’t trade the 2nd pullback as it is not reliable enough (symmetric triangle pattern), but it is a valid pullback nontheless.

Patterns in which you can trade the pullback:

The stock chart patterns that have this signal:

Double Top
Double Bottom
Triple Top
Triple Bottom
Head & Shoulders
Descending\Ascending Triangle
Channel
Round Bottom

Stock chart patterns that you should not trade with this signal:

Wedges
Pennants
Flags
Symmetrical Triangle

In conclusion, the pullback is one of the most accurate chart trading signals and if you learn how to trade it you can achieve amazing hit-rate in your trades, and very good long-term profits.