Pullback To My Price, Please!

In my last post I discussed breakout trades. Well, there is really only one other type of trade to think about, and that's a pivot trade based on some form of price reversal. Here is one such trade, which makes up the majority of trades that I execute each month. The trade takes place when price is in a trend (umm, that's probably an entirely separate post to define exactly what that means in a precise way, but lets not worry about that now). I see the trend (or have anticipated it in advance) and I want a piece of the action. But not at any price. Price action always forms impulse waves characterised by moves in the direction of the trend, followed by either consolidation patterns or corrections that pullback against the trend. Below is an example of price moving upwards, but with the start of a pullback.



Based on the recent swing high in price, and the most recent significant swing low, I draw Fibonacci retracement levels (fibs). I set up a limit order to enter long on the currency pair if the price reaches the 61.8% fib level ( price level 8916 on the above chart), with a contingent stop order just below the 100% level (at 8990, so a 26 pip stop for this trade). I use a limit order because price may only momentarily touch this price level, plus I want to take emotion out of the trade.

Now wait and watch. Or better still, don't watch!



So far so good, I'm in the trade, and I'm pleased to see that price broke the entry price level but didn't close below it. At this point I should say that I actually place multiple entries at this price level (i.e. separate limit orders) all with the same stop level but with varying exit prices. Since this is effectively a counter-trend trade (in the short term), there is a risk that this is not a pullback but a reversal in price action. For the trend to continue price needs to break higher than the recent swing high. However, even if it fails to do this, I at least expect a bounce in price to the zone between the 23% and 38% fib levels. So here I place my first exit.



So far so good. At this point price is range bound between the latest swing low (the pivot bar that took me into the trade) and the recent swing high (from where I measured the fib retracement). The price might bounce around here for a short time, whilst it decides what direction it wants to go. If it were to break below my entry price I would be tempted to close out my position without waiting for my stop loss to be hit, and still easily breakeven due to my partial exit. But even if the trade gets stopped out, my loss has been reduced from the initial risk exposure. There is also the possibility that price will move down from the 23% fib level to the 78% level (not shown - lower than my entry but above my stop) and form a bullish gartley pattern. This is illustrated below (for a different currency pair):



This possibility has influenced the way I trade pullbacks as discussed here.

OK, back to the trade in question, and the reason for doing this pullback trade. The expectation is that the price will break above the recent swing high and continue its upward trend. Here it is ...



Sweet :)

Converging Breakout

Breakouts are classic trade setups that you'll find in any text book on technical analysis. Just because it's simple doesn't make it any less effective!



The price bars form a horizontal consolidation level and the expectation is that the price will break out of this level in the direction of trend continuation.

Here is the happy ending - a 180 pip move over a 5 hour period (against a stop loss of 22 pips). The red line is where I had a trailing stop so my actual gain was about 100 pips - significantly less than the full move, but I couldn't justify a tighter technically valid stop level.



Anyone who has traded breakouts knows that it's not always this simple. Here is a breakout that would have failed if traded:



Fortunately I anticipated that this breakout would fail, and placed a short term long position at the base of the spike in price that occurred at 22:30.

The approach I use to increase the chance of success on breakouts is based on what I have learnt from Nick McDonald. Prices can make sharp counter-directional moves due to snap-backs to moving average levels or negative divergence.

The first thing to check is that the break out is consistent with a trend continuation. This can be confirmed by looking at the overall trend on the current chart (15M) and the next time frame up (1H). All moving averages should be aligned and price should not be extended beyond the 10-20 MA zone. Next there should be no evidence of negative divergence. In fact, more strictly, the MACD and RSI indicators should display the same break out pattern as price.

There also needs to be the opportunity to set a very tight stop loss level that is still technically valid (i.e. defined by price action).

Finally here is another illustration of the convergence between price breakout and indicator breakout:



Notice in particular the convergence of the blue signal line on the MACD with price action. It's also worth pointing out that earlier in the day price was setting up for an upward breakout, but there was divergence with the indicators indicating either the breakout would not happen, or it if did then there would be a high possibility of it being a false breakout.