Learning how to profit from trading pullbacks is simply the most profitable approach to trading. You must have heard the phrase “The trend is your friend” and the most convenient way to trade in the direction of the trend is by implementing a pullback trading strategy. Our team at Trading Strategy Guides puts a lot of focus on trend direction and as such we’ve developed our own trend following system MACD Trend Following Strategy- Simple to learn Trading Strategy.
Trading pullbacks in trends is a basic trend following strategy. There are many different ways to profit from trading pullbacks and in this step-by-step guide; we’re going to show you a very practical way on trading pullbacks in trends.
You can profit from trading pullbacks on all time frames because a trend can show up from the 5-minute chart all the way to the monthly time frame. In this regard, no matter if you’re a daytrader or a swing trader you can safely apply our pullback trading strategy.
Before we start covering in depth the rules of our practical pullback trading strategy we’re going first to define and learn how to recognize a pullback.
What is a Pullback?
A pullback simply represents any price movement that is against the prevailing trend. Basically, if we’re talking about trading pullbacks in trends we’re basically entering in the direction of the trend as the market has traded at a lower price.
The pros of trading pullbacks in trends are that you’re basically buying low and selling high. If we’re trading pullbacks in an uptrend you’re basically buying low and if we’re selling pullbacks in a downtrend we’re basically selling high.
The second advantage about trading pullbacks in trends is that it’s actually easier from a psychological stand point of view because you have the trend working out for you.
Before we get started, let’s look at what indicator you need for the job for the pullback trading strategy:
The First and ONLY indicator you need is the:
Fibonacci Retracement Indicator: This indicator simply draws the Fibonacci ratios that can be used to identify potential support and resistance levels from where the price can reverse. Check out the “What Goes on at Support and Resistance” areas if you have no prior knowledge as to what this is.
When trading pullbacks in trends the most important Fibonacci levels are the 38.2%, 50% and 61.8%. Normally, it all comes down to the strength of the trend how far the pullback will go. Usually, the stronger the trend is the smaller the pullback will be in which case it can only reach the 0.382 Fib retracement.
Now, let’s see how you can effectively trade pullbacks and how to make profits from trading pullbacks by simply following our pullback trading strategy.
Pullback Trading Strategy Rule – Buying Opportunities
The power and the secret of the pullback trading strategy are all contained by the fact that we’re aiming to trade in the direction of the trend by entering on a pullback. Trading pullbacks in trends really offer you with the opportunity to lower your risk while maximizing your profits.
Obviously, in order to profit from trading pullbacks, we first need to define the trend so we make sure we only trade pullbacks with the trend because this is the setups that can make us big profits.
Step #1: Identify a Bullish Trend which is characterized by a Series of Higher Highs and Higher Lows
Identifying the direction of the trend should be a fairly easy process. The easiest method that our team at Trading Strategy Guides likes to use to identify the trend is the swing high and low structure. In essence, an uptrend is defined as a series of higher highs followed by a series of higher lows.
Note* It’s important to use the higher time frame to determine the trend regardless of the time frame you normally base your trades on. If you’re interested to learn more about the benefits of multiple time frame analysis, we have your back covered, you can continue reading Trading Multiple Time Frames- The Key to Successful Trading.
Step #2: Switch to the 1h Time Frame and Wait for a Pullback against the Uptrend
After successfully identifying the trend, we can switch lower to our preferred time frame. It can literally be whatever time frame you feel more comfortable with but, for the purpose of this pullback trading strategy, we use the 1h time frame.
Now it’s time to bring into play the Fibonacci Retracement tool, which brings us to the next step of our pullback trading strategy:
Step #3: Place Your Fibonacci Retracement Indicator between the last swing high and low levels, prior to the pullback.
Identify the most recent swing low and swing high and place your Fibonacci retracement indicator between the two swings. If you still have problems to recognize how a proper swing high and swing low level should look like read our Best Stochastic Trading Strategy- Easy 6 Step Strategy
Next, we need to figure out where we need to get into the trade, which brings us to the next step of our pullback trading strategy:
Step #4: Buy Anywhere Between the 50% and 61.8% Fibonacci Retracement area
After you’ve placed the Fibonacci retracement mark on your chart the area between the 50% and 61.8% Fibonacci retracement and buy as soon as we trade within that area. It’s up to you whether or not to buy as soon as we hit the 50% or to wait for the 61.8%.
With experience, you’ll be able to fine tune your entry and profit from trading pullbacks.
Now that we’re in a trade it’s time to figure out where to hide our stop loss which brings us to the next step of our pullback trading strategy.
Step #5: Place the Protective Stop Loss below the Swing Low
The last swing low used to draw the Fibonacci retracement levels can provide us with a very attractive place to hide our protective stop loss.
A break below the last swing low will invalidate the trade so we want to minimize our losses and get out of the trade.
In order to profit from trading pullbacks, we need a smart strategy to maximize the potential profit which brings us to the next step of our pullback trading strategy.
Step #6: Take Profit once we break above the Previous Swing High
In order to profit from trading pullbacks we need a strategy for taking profits as well. In this regard, the ideal place to liquidate our position is once we make a new high.
The market never moves in a straight line and most of the time after we break to new highs a pullback occurs most often than not. So, if you want to be in an out of the market very quickly that’s the easiest way to profit from trading pullbacks.
Alternatively, if we want to maximize our profits we can only take half of the profits once we break to new highs and the remaining half of our position to be taken at 100% Fibonacci extension.
Note** The above was an example of a BUY trade… Use the same rules – but in reverse – for a SELL trade. In the figure below, you can see an actual SELL trade example, using our pullback trading strategy.
Trading pullbacks in trends can be one of the most rewarding trading strategies out there. The pullback trading strategy is a time-tested profitable strategy and the key to its high rate of success is given by the fact that we’re trading in the direction of the prevailing trend.
The way to profit from trading pullbacks is by simply buying weakness in an uptrend and selling strength in a downtrend which is what the pullback trading strategy presented in this step-by-step guide is trying to accomplish.
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