Home Guides Trading for Dummies Complete Strategic Guide to Trend Pullbacks – Tools, Setups & Risk Management

Complete Strategic Guide to Trend Pullbacks – Tools, Setups & Risk Management

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Definition

The market moves in trends, which is powerful. This gives us a high probability to make money in the financial markets. Trend pullback in simple terms denotes that, if the institutions are buying a financial asset, they will not continuously buy it. Instead, they’ll wait for a discount.

In the real world, how we tend to wait for a discount or better price to buy any product or service, the same is the tendency of the institutions as well. Basically, markets can be associated with real-world business.

When we have a huge difference in sales in comparison to the previous sales (Demand in technical terms) of a product or service, then we identify that the product is trending in the market and many common people also realise that there is a trend for this particular product or service. So, many will look for a discounted price to join the overall trend of the product/service/financial asset. Ex: Bitcoin and other cryptocurrencies.

 “Never chase a trend, anticipate the trend.”

The working of trend pullback

The basic definition of “trend” in the financial markets is a series of Higher High’s (HH) and Higher Low’s (HL). Such a market is called an uptrend. Similarly, a series of Lower Low’s (LL) and Lower High’s (LH) is called a downtrend. These HH’s and LL’s are called pushes or strong movements, and LH’s and HL’s are called as pullbacks (discount price).

As a trader, we have to wait for the HL’s or LH’s to develop, and then anticipate if the overall trend will resume or not. Thus, the whole analysis is based on inspecting the LH (Downtrend) and HL (Uptrend) like a hawk.

How many timeframes are required to trade a trend pullback?

There is a lot of misconception in the market that, people have to look at the daily chart to see the direction of the BTC, come to the 15 mins chart to execute the trade and move on to the 5 mins to understand the movement precisely. Well, all of this is complete nonsense. This is where the retail traders make mistakes and whales (big institutions) make money.

As a professional trader, you need to use only two timeframes for analysing the markets; one timeframe for determining the direction and the other for execution. The directional TF gives an idea of how the overall trend is looking, and the execution timeframe ( or Trading Timeframe (TTF) gives a detailed overview of the trend and the pullback. The trading timeframe (TTF) also helps in determining the Target and Stop loss for a trade.

Important note: All the analysis should be done only on the TTF. Because if you go to a shorter TF, you will end up entering early; and if you go up an upper TF, you will end up waiting too much. So, if you implement this, it will make you focus on the trade, rather than watching each and every TF to get to a conclusion.

Below are some of the best combinations for determining the Directional timeframe and the Trading timeframe

If your directional TF is 1D, then choose4H as your TTF

If your directional TF is 4H, then choose1H as your TTF

If your directional TF is 1H, then choose15min as your TTF

If your directional TF is 15min, then choose5min as your TTF

If your directional TF is 5min, then choose1min as your TTF

Analysing a Trend Pullback

When you are reading a trend pullback, the basic rule is to confirm that the HH (Push) should be strong (Swift movement) and healthy (Less time) compared to the pullback (Retracement). This confirmation will tell that the overall direction is good, as the Intuitions are buying the asset/taking the asset for a higher price and at a faster rate.

This swift move of the market causes panic to the retail traders. They don’t wait for fora better price and end up chasing the trend. This is pretty dangerous, as they don’t know until where and for how long the market will go.

Hence, one must be patient until the push, and the pullback comes to an end, as many pro traders proclaim that trading is a game of patience.

“Never catch a falling knife or never board a running bus.”

Image 1: Uptrend

An uptrend begins by making a high. And, the move from the high to the HL is called a pullback. When the price makes an HH (by breaking above the high), then the previous (here, first) HL will be the Low and HH will be the high. This cycle is called an uptrend.

When can we conclude that the uptrend has come to an end?

Misconception:

If the price goes below the HH, then it means that the uptrend has come to an end and the downtrend has begun.

Fact:

When the most recent HL gets taken out, then it can be said that the uptrend has ended and the downtrend is going to commence.

The better you understand the difference between the misconception and the fact, the better the trader you will be.

Note: When the previous high gets taken out, and the price holds above that high, then it is called as a HH. Conversely, when the Higher Low is challenged but is not taken out, then it is still called an HL.

Image 2: Downtrend

A downtrend begins by making a low. And, the move from the low to the LH is called a pullback. When the price makes a LL, the previous (here, first) LH will be the High and LL will be the Low. This cycle is called a downtrend.

When can we conclude that the downtrend has come to an end?

Misconception:

If the price goes above the LL, then it means that the downtrend has come to an end and the uptrend has begun.

Fact:

When the most recent LH gets taken out, then it can be said that the downtrend has ended and the uptrend is going to commence.

Note: When the previous low gets taken out, and the price holds below that low, then it is called as a LL. Conversely, when the Low/LH is challenged but is not taken out, then it is still called an LH.

Image 3: Turnaround

Starting from the left, the market started off by making a Low (L), LH, LL, LH and a LL. Moving forward, the price didn’t hold below the recent LL but went up until the previous LH. However, you still have to consider this as a low (L).

When the previous LH is challenged, it is a sign that the market is preparing for a turn around (uptrend). Once the market hold above the previous LL, i.e., it makes HL, we can say that the uptrend is real.

Now, if we were to read the market as an uptrend, we must consider the Red “L” and the Red “H”. And, as the price is holding above the red “L”, then we can consider that as an HL. Later, the price continues its uptrend by making a HH, HL, HH, and so on. Hence, this is how the market works with sellers and buyers.

 

Tools Required

Candlesticks

Each and every candlestick represents the Power, Strength and Volatility of the market.

In a 1H timeframe candlestick chart, all the transactions that happen during the hour will be represented in one candlestick. Similarly, in a 1D timeframe candlestick chart, all the transactions that happen during one whole trading day will be represented in one candlestick. Based on this, we can conclude how powerful each candlestick is.

And, by comparing it with another timeframe candlestick’s power and distance, we can determine if there is still momentum or not. For example, when you’re looking at the 1D, you can see the development of the candle on the 4H TF, as the 1D candle is segregated into eight candles on the 4H TF. By reading the power, distance and time taken from open to close or close to open of these eight candles, we can conclude if there is still momentum on the 1D or not.

Each and every candle has its own significance, and nothing is subjective here. One candle can change the whole perspective of the market condition, so the location of this candle plays a significant role in the market as well.

Volumes

The volume of the market plays an important role in trading and investing. Volume represents how orders are filled in the market. This gives an extra edge in determining whether the institutional players are interested in buying BTC or any other financial asset at the location/price where you are interested in buying.

When the volumes are above the moving average, then it is a clue that the whales are kicking into the market. However, since cryptos are not based on centralised exchanges, there will be less weight for volumes. But, volumes of highly trusted exchanges can be believed.

Volumes + Candlesticks

Sometimes price moves swiftly without any reason. For example, if there are 1 Million Buy orders at 3000 USD per BTC and only 0.1 Million sell orders at 2800 USD per BTC, then the price has to move (artificially) to 3000 USD area for filling its orders. So, the price movement is assumed to be fake.

If we dig deep into it, what actually happens is that the price moves swiftly from 2800 USD to 3000 USD, fills up the orders and then goes for a sell, which makes retail traders jump in for a buy. Hence, believing the price movements backed with volumes gives us extra confirmation, if the move is real or fake.

“Nothing is subjective in financial markets, and everything is objective.”

Image 4: Example of real price movements backed with volume

Reading the chart from left to right, in the first double arrow, as the Volume is not above moving average, we shouldn’t trust the big green candle that appeared. Also, due to this less volume, the big green candle couldn’t even make a higher high.

However, the 2nd and 3rd arrow’s volume is above the MA with big green candles. Hence, we can trust this move. And, we can see that the market did make a higher high this time.

How to read the momentum (Down Trend)

From the above image, the left chart represents the Directional TF, and the right chart represents the TTF (Trading TF).

Time Frame Analysis
  • On the Directional TF, we have a break from the support (Blue Ray) with a strong and emotional red candle. Hence, this confirms that the trend is towards the downside.
  • On the TTF (15mins), the momentum and volume analysis is done, which is discussed in the subsequent topic.

Note: This strategy is applicable to any TF. Here, in this example, we shall be using the 1H and the 15mins timeframe.

Trading Timeframe Analysis (Momentum + Volume)
  • Comparing the move from L to H with High to HL with respect to momentum and volume, we can say that the retracement of the sellers (high to HL) is just 20%.
  • Now, as the previous High was taken out and the market made an HH, the HL becomes the new low. Comparing the push from the new Low (Previous HL) to HH with seller’s pullback, the retracement is again 20%. This indicates that there is still momentum of the buyers.

Note: When there is a 100% retracement, then we can say that the buyers are dead in the seller’s market.

  • Moving forward, now the immediate HL will become the new Low (L), as price made a Higher High from the previous high (HH).
  • Lastly, from the most recent HH to the following Low, the market made a 120% retracement, which means that the last HL has been taken out. Therefore, this tells us that the buyers are dead in the seller’s market. This is also is a sign that we are getting closer to the entry to go short.
Comparing the Momentum
  • If each push is slowing down compared to the subsequent pushes (from the First black line to the second black line to the third black line), then it signifies that the momentum of the buyers is dying in the seller’s market (1H TF).
  • Therefore, any price after a 100% retracement (HL taken out), will be a good price to go for a short.
Manipulation Area
  • When the Directional TF is telling a sell and the TTF is telling a buy (Pink support ray), it creates a conflict between the two TFs. Hence, GOING WITH THE DIRECTIONAL TF FLOW IS ALWAYS THE BEST CHOICE.

How to read the momentum (Up Trend)

From the above image, the left chart represents the Directional TF, and the right chart represents the TTF (Trading TF).

Time Frame Analysis
  • On the Directional TF, we have a break from the Resistance (Blue Ray) with a strong and emotional candle. Hence, confirming that the trend is towards the Upside.
  • On the TTF (15mins) the Momentum + Volume analysis has to be done.

Note: This strategy is applicable to all timeframes. Here, in this example, we shall be considering the 1H and the 15min timeframe.

Momentum + Volume Analysis (TTF)
  • Compare the H to L with the L to LH with respect to momentum and volume. We can see that the buyers retraced 90%. However, note that 90% retracement is not a 100% retracement. So, we cannot conclude that the sellers are completely dead. Moreover, the sellers took only three candles to reach the low from high, but the buyers took five candles and still couldn’t challenge the high.
  • Now, the LH will become the new High, as the previous Low made aLL. Comparing the push from High (Previous LH) to LL with the retracement (LL to LH), the buyers retraced only 20%, indicating that the sellers are still around.

Note: Once there is a 100% retracement, then we can say that the buyers are dead in the seller’s market.

  • Carrying on, the immediate LH will become the new H even though the price couldn’t make aLL from the previous low. This must catch some interest in us because the price is in the area of the Directional TF’s S&R, which is a very important level for us.
  • Now, from the most recent LL to the High, the Buyers retraced 100% and took out the LH. This tells us that the sellers are dead in the Buyer’s market. Also, this is a sign that we are getting closer to the entry to go long.
Comparing the Momentum
  • If each push is slowing down compared to the subsequent pushes, then it means that the momentum of the sellers is dying in the buyer’s market (1H TF).
  • Hence, any price after the 100% retracement (LH taken out), will be a good price to go for a Long.
Manipulation Area
  • If the Directional TF is telling a Buy and the TTF is telling a Sell (Pink support ray), it creates a conflict of interest between the two TFs.If you wish to stay in the right direction most of the time, then GOING WITH THE DIRECTIONAL TF FLOW IS ALWAYS THE BEST CHOICE.

Placement

Stops Loss

For a short trade, the Stop-loss should always be above the last high (Conservative entry) or above the LH (Aggressive Entry).

For a long trade, the Stop-loss should always be below the last low (Conservative entry) or below the HL (Aggressive Entry).

Take Profit (TP)

Take Profit can be at the recent High for a long trade and at the recent low for a short trade.


Risk Management

Risk Management is the key to trading, as trading is based on probabilities and uncertain market conditions. So, controlling the risk is basically the best idea than making money.

Position size for Trend Trade
How to calculate the position size

A rule for many traders is, not risking more than 2% of the account. If you want to make big money in the market, then increase your account size, not the % risk on your account.

I suggest that you must never risk more than 2% of your trading account per trade.

What’s the reason behind that?

If you limit your risk on each trade to 2% of your trading account, you will almost guarantee long-term sustainability.

This Position Size Calculator will help you with that:

Position Size Calculator

How To Calculate Your Position Size

If you want a quick hack, here’s a formula you can use to calculate your position size:

For Long position: ((Trading Portfolio * Risk % per trade) / (Entry Price Stop Loss)) * Entry Price

If you want to calculate the position size for a short position, then swap the entry price and stop loss in the formula.

Risk-Reward (RR)

The risk to Reward is basically the amount you are risking vs the amount you are gaining. For example, a 1:1 RR means, you’re risking 2% on your account to make 2% on your account. Similarly, a 2:1 RR means, you’re risking 2% on your account to make 4% on your account. Note that, your minimum RR should be 1:1.

RR matters in trading. If you are trading a 1min, 15min, 1H or 240 mins TF, the distance doesn’t matter. All that matters is the RR because the profit or loss % will not change if you are trading a 1H or 1D or 1W TF.

When will this strategy work?

There are pros and cons of each strategy. There are factors like momentum and volume, which determine if the strategy will work or not. Let’s understand some points when the strategy is sure to work.

  • Breakout with momentum and volume must be above the MA on HTF (Directional TF).
  • The pullback should come deep enough with lows volumes (Possibly below MA) and low momentum on the TTF.
  • Subsequent pushes of the pullback should be weakening (Strength, Time and Distance) on the TTF.
  • If the breakout is to the downside on the Directional TF, then on the TTF we have to see HH’s and HL’s so that a retail trader thinks that the market is switching to an uptrend. Because we need buyers to do our sells and sellers to do our buys.
  • When the buyers are approaching near the S&R of the Directional TF, we need to have a 100% retracement of the last push to confirm that the overall sellers are back in the game. Also, the 100% retracement should be coming up with high volume and momentum (Above the MA).
  • We need a conflict in the TFs. If one TF (Directional TF) is telling a sell, then the TTF should say it a buy.
What might go wrong even if everything looks good

When you are dealing with any financial assets, risk can be alleviated and controlled but not neglected, as this is a game of probabilities. But when Risk Management comes into play, then you can automatically make money.

Economic Events:

Economic events are the ones which might cause spikes in the market and can take your stop loss. As being a conservative trader, you are supposed to avoid taking a trade when there is news release. However, you can trade after the news release. But, when it comes to Cryptos, there will be news without prior notice as this is decentralized market and not a centralized currency like USD, where you will know that the centralized body will announce the NFP and Interest rates on a particular day, week or month.

Panic Activation:

Cryptos are new in the market which has its own pros and cons. Let’s say that, in India, there is a major BTC exchange that closed and the news about it is around the world. This causes panic, where emotions will kick in, and most retail traders will end up selling their asset. This usually happens when you’re trading the lower timeframe.

Exchange Hacks, BTC Frauds, MLM schemes exposed etc. are other examples which might cause panic in the market.

Hope you understood the concept of Trend pullback. Got any questions? Shoot them down in the comments below. Happy Trading!

 

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