The Definitive Guide to Trading Pullbacks and Breakouts

Here’s  the thing:

No matter how many entry techniques you learn, there are only 2 ways to enter a trade.

On a pullback. On a breakout. And that’s it.

But many of you struggle with this concept.

You probably have thoughts like…

How do I know where a pullback will end?

Breakout tends to fail, I hate trading breakouts.

Should I wait for confirmation, or not?

Don’t worry.

Because in this post, I’ll teach you the essentials of trading pullbacks and breakouts.

You’ll learn stuff like:

• The 5 levels the market will likely retrace to (so you can “predict” market turning points)
• How to find high probability pullback trades
• How to spot explosive breakout trades before it occurs
• And much more

Are you ready?

Then let’s begin…

What is a pullback?

A pullback is when price temporarily moves against the underlying trend.

In an uptrend, a pullback would be a move a lower.

Here’s an example:

And…

In a downtrend, a pullback would be a move higher.

An example:

According to the work’s of Adam Grimes, trading pullback has a statistical edge in the markets as proven here.

You may wonder:

What are the pros and cons of trading pullbacks?

Advantages of trading pullbacks:

• You get a good trade location as you’re buying into an area of value. This gives you a better risk to reward profile.

Disadvantages of trading pullbacks:

• You may potentially miss a move if the price doesn’t come into your identified area.
• You’ll be trading against the underlying momentum.

Now, this brings you to the next question.

Where does the pullback end?

You can’t predict with 100% accuracy where pullbacks will end.

But here are some guidelines:

1. Towards previous resistance turned support

2. Towards previous support turned resistance

3. Towards a dynamic support

4. Towards a dynamic resistance

5. Towards a Fibonacci retracement

Now:

You have an idea where price could potentially retrace to.

This brings you to the next question…

Do you wait for confirmation?

A confirmation is when a candle closes in your direction, confirming your initial trading bias.

This increases the probability of your trades.

An example…

However…

While waiting for confirmation, you get a poorer risk to reward. Because you’re entering your trades after the price has moved in your favor.

And sometimes…

It could cause you to miss a big move like this:

So…

Do you wait for confirmation?

There’s no right or wrong answer here, but rather what suits you best.

Whichever choice you make, you must know the possibility and consequence that comes with it.

Now, let’s put this knowledge to use…

How do you develop a system to trade pullbacks?

Before you can develop a system, you need three things:

• The condition for your setup
• Your entry
• Your exit

Disclaimer: Below is a random trading plan I’ve created to illustrate my point.

If 200 EMA is pointing higher and the price is above it, then the trend is bullish (Condition).

If the trend is bullish, then wait for the price to pullback to an area of support (Condition).

If price pullback towards your area of support, then wait for a higher close (Condition).

If price closes higher, then enter long at next candle open (Entry).

If you are long, then place your stop loss below the low of the candle, and take profit at swing high (Exit).

Vice versa for a short setup.

By using the IF-THEN syntax, it keeps your trading more objective with lesser room for discretion.

Now:

Here comes the exciting part…

How do you find high probability pullback trades?

If you want to find high probability trades, you need to look at something called confluence.

What’s that?

A confluence is when 2 or more trading tools come together to give the same trading signal.

Example 1:

Example 2:

Alternatively, go read Moving Average 101, by Steve Burns, to learn how to incorporate moving average into your trading system.

Now here’s the thing:

More confluence:

• Higher probability trades
• Lower frequency of trades

Less confluence:

• Lower probability trades
• Higher frequency of trades

It does not make sense to only wait for high probability setups because you may end up with very little trades.

Likewise, you don’t want to be taking trades all the time just because a single indicator gave a buy/sell signal. If you want more explanation, read How To Trade Like A Pro: Take Mediocre Setups by Tradeciety.

My suggestion is to have a confluence between 2 to 4 factors.

Some confluence factors you can consider:

• Trend
• Support & resistance
• Moving averages
• Multi-year highs/lows
• Oscillators overbought/oversold
• Candlestick patterns

Right now:

You’d probably realize there’s an endless combination you can come up with. To find out whether it can be consistently profitable, you’d have to test it yourself.

Moving on, let’s talk about breakout…

What is a breakout?

A breakout is when price moves outside of a defined boundary.

The boundary can be defined using classical support & resistance.

Breakout to the upside:

Breakout to the downside:

You’re wondering:

What are the pros and cons of trading breakouts?

Advantages of trading breakouts:

• You will always capture the move.
• You are trading with the underlying momentum.

Disadvantages of trading breakouts:

• You get a poor trade location as you’re paying a premium.
• You may encounter a lot of false breakouts.

Despite the possibility of false breakouts, it should not deter you from trading it.

Why?

Because the best traders in the world love trading breakouts.

I turn bullish at the instant my buy stop is hit, and stay bullish until my sell stop is hit. Being bullish and not being long is illogical. – Ed Seykota

When I’m bearish and I sell a stock, each sale must be at a lower level than the previous sale. When I am buying, the reverse is true. I must buy on a rising scale. I don’t buy long stocks on a scale down, I buy on a scale up. – Jesse Livermore

Now, this brings to the next question…

How do you identify a potential breakout before it happens?

In a range market…

1. Mark the highs and lows of the range

2. Pay attention if price trades beyond the highs/lows of the range

Here’s an example:

And another…

Now, let’s move on to trending markets…

In an uptrend…

1. Identify a swing high

2. Pay attention if price trades above the swing high

An example:

In a downtrend…

1. Identify a swing low

2. Pay attention if price trades below the swing low

Here’s an example:

Now you know how to anticipate a potential breakout, and this leads you to the next question…

Do you wait for confirmation?

For breakout trades, a confirmation would be a candle close beyond the highs/lows you’ve identified.

An example:

But it comes with a price…

You may potentially end up missing a huge chunk of the move.

Here’s an example:

So…

Do you wait for confirmation?

This depends entirely on your trading personality. There’s no hard and fixed rule about it.

If you’re someone who prefers a candle close, then wait for a confirmation.

If you’re someone who prefers a better risk to reward, then trade without confirmation.

But bear in mind both has their pros and cons, and it’s something you have to accept.

Confirmation

• Easier to execute the trade psychologically
• Poorer risk to reward

No confirmation

• Harder to execute the trade psychologically
• Better risk to reward

Now, let’s put this knowledge to use…

How to develop a system to trade breakouts?

Likewise, before you can develop a system, you need three things:

• The condition for your setup
• Your entry
• Your exit

Disclaimer: Below is a random trading plan I’ve created to illustrate my point.

If the price has been in a range for the last six months, then place a buy stop order at the high of the range (Condition).

If a trade is triggered, then place a stop loss at the low of the previous candle (Entry and exit).

If the price goes in your favor, then look to trail your profits at the low of the previous candle (Exit).

Vice versa for short setup.

Now here comes the best part…

The secret to finding explosive breakout trades

The market tends to move in a cycle.

From a ranging period to a trending period, and vice versa.

The longer it’s in a range, the bigger it’ll trend later on.

An example:

And another…

So…

If you notice the price has been ranging for a long time, you’re not alone.

Traders all around the world will be seeing the same charts as you.

Some will be queuing to short the resistance, and some will be trading the breakout.

If the price does trade above the resistance, shorts will get squeezed, and breakout traders will hop on the bandwagon.

This is why price trend for a sustained period of time, due to the imbalance of buying/selling pressure.

Conclusion

You’ve just learned how to successfully trade pullbacks and breakouts.

Now it’s time to put these techniques into practice.

The next step?

Click on the link below and enter your email to get access to my FREE cheat-sheet on trading pullbacks and breakouts.

This cheat-sheet has all the techniques that were taught here…and an extra one, which I didn’t have room to include in this post.

Notes: This post was seen on:

https://www.tradingwithrayner.com/how-to-trade-pullbacks-and-breakouts-successfully/#

Credits to: Rayner Teo