Pullback trading strategies

01 What is a pullback?

A pullback in technical analysis refers to a temporary price correction against the prevailing trend. It is sometimes known as “retracement.”

It happens when prices slightly withdraw from recent highs or lows and usually unfolds over a few days to weeks on a daily chart before the initial trend picks back up.

This is distinct from a reversal, which signals a more profound and enduring change in price direction.

Pullbacks can be interpreted as the market's “breather.” They’re a standard feature of market behavior and may result from traders cashing in profit, shifts in market sentiment mood, or adjustments in supply and demand.

A pullback signals to traders that the primary trend is on a temporary hold, offering an opportunity to capitalize on short-term price adjustments within the overarching trend.

02 How to identify a pullback?

The first step in identifying a pullback is to determine the prevailing trend, either upward or downward.

Traders typically use tools like trend lines or moving averages to identify the direction of the trend. In an uptrend, for instance, prices tend to make higher highs and higher lows.

Pullbacks occur when the price starts to retrace a portion of its prior upward movements, typically no more than 5%-10% decline in price. These moves against the trend are generally brief and often halt at potential support zones before the price resumes its climb.

Potential support or resistance levels can be prior highs or lows, trend lines, and moving averages.

Traders also look to Fibonacci retracement levels for possible support or resistance, and more critically, to gauge if a price reversal could be imminent.

As a rule of thumb, the price retracement should not surpass 61.8% of the prevailing trend, or it would be considered a trend reversal, which signifies a more fundamental shift in the market’s direction.

03 Case study

Chart 1 shows using an uptrend line to help identify potential pullback levels. Trend lines can be quite simple to determine a prevailing trend. The drawback, however, is that they often take longer time to be validated.

Chart 2 displays the 50-day moving average (MA50) situated beneath the price action. Many traders use the MA20, MA50, or even the MA200 to gauge market sentiment. Generally, when the price is moving above the MA50, it is considered a bull market in the short and medium term and the MA50 might act as potential support for a pullback.

Chart 3 illustrates a much larger pullback following a strong uptrend where the price has nearly doubled. As you can see, the price breaks below the MA50, indicating a potential reversal of the trend.

In this regard, traders might deploy the Fibonacci retracement tool to identify potential support levels and estimate how far the price might travel.

Chart 4 shows the Fibonacci retracement levels are created by connecting two significant price points. Fibonacci followers would tend to pay close attention to major retracement levels, such as 38.2%, 50%, and 61.8%, at which levels there is more likely to see the potential end of the pullback.

Chart 5 illustrates a breakout pullback strategy. A breakout occurs when the price rises above the horizontal resistance line, forming a sizeable gap up. After a few weeks, the price retraces to this horizontal line then rebounds from it. This bounce is seen as a potential confirmation that the price may resume its previous upward trajectory.

This presentation discusses technical analysis, other approaches, including fundamental analysis, may offer very different views. The examples provided are for illustrative purposes only and are not intended to be reflective of the results you can expect to achieve.

All investing involves risk, including the potential loss of principal, and there can be no guarantee that any investing strategy will be successful.