Pullback and breakout entry styles in trend trading

  • By Jeff Cartridge

  • September 20, 2018
  • 7:03 pm BST

Trading according to trends is a popular way to stay ahead and create beneficial opportunities. This method allows you to identify price trends, analyze their qualities and plot trades accordingly. Trend trading is suitable for many markets, such as stocks or forex trading, and it can be applied to beginner or experienced trades. One good technique when trading trends is to enter after a pullback, as the direction will move back to its original trend. However, another popular technique is taking the approach of entering after a breakout, which can be more beneficial.

Recognizing trends

Several methods can be used to recognize market trends. Many of these techniques are complex, but they don’t have to be in order to assist you successfully. One of the simplest ways to identify a trend is to determine whether a price is higher or lower than its average over a certain period of time. This alone will help in predicting the direction of future price movement. These periods of time can be anywhere from one to six months, with the latter being more effective.

Pullback entries

You can identify pullbacks when a new one-day low is reached for a price during an uptrend, or alternatively when a price reaches a new one-day high during a downtrend. Simply put, a pullback occurs when the price turns around in direction temporarily during a current trend. These could be trends that formed over three or six months. A pullback will be either above or below the previous low or high.

In this case, it is also advisable to allow the four-hour candlestick to span over a range that is longer than the general 30-period average true range (ATR) usually used. This method works on a favorable risk-to-reward ratio, which in turn creates more opportunities to earn profits. As with all forex trading advice for compiling strategies, it is vital to backtest these methods.

Breakout entries

Breakout entry techniques are often used in stock and commodity trading and can prove very profitable, but they are used less often in the forex market. Pullback entries might often seem like a better choice for this market, particularly because of the logical methods behind the price movement. However, there is one downfall found with pullbacks: false starts. Also known as whipsaws, these are one of the biggest problems traders come across when trend trading. These occur when your strategies send a trade signal, only to be followed by a reversal, causing your position to be stopped.

A breakout strategy can avoid this problem with the use of secure filters, allowing you to identify the best places to enter in a trend. The following steps can be taken to implement a reliable breakout strategy:

  1. Use a four-hour candlestick chart to follow the trend direction.
  2. The simple moving average of the 18 period should be the trend side of the simple moving average of the 60 period.
  3. The current high or low should be above or below that of the previous candlestick trend side.
  4. The 10 period relative strength index should be more than 50 for an uptrend or less than 50 for a downtrend as the candlestick closes.
  5. The 30 period average true range should be less than the high-to-low range of the above-mentioned closed candlestick.

These steps allow for the long-term and short-term trends to be coherent when placing entries. The most important indicator for this method is the relative strength index, which forms the basis of each step. As mentioned previously, this strategy should also be backtested before it is implemented.

Both of these methods provide many advantages, with the breakout entries being better for small targets and the pullback entry method being better for bigger targets. You can test these in your own trades to find which one best suits your trading goals and personal style.