How to Trade Pullbacks

Here is a scenario that almost every trader will be familiar with. A fast-moving market makes a move, rallying or tanking to some extreme. But regrettably, you were unable to get on board because the move was too quick. Do you jump in and risk buying the top or selling the bottom, or pass on the opportunity altogether?

Patience, as well as a sound strategy for trading pullback patterns, serves traders well in situations such as these. So bide your time and look for the following pattern to climb on board with defined risk once the momentum resumes.

Pullbacks

If you're looking to get long, wait for at least a three-day pullback in the market after a move to an extreme, here defined as a 20-day high. On the fourth, fifth, sixth or seventh day of a pullback from the high, enter long at the high of the low bar in the pullback: that's your long trigger. Your risk is defined by placing a stop below the low of the same bar. The recent run-up in June Australian dollar futures (ADM2: CME) illustrates the pattern.

The setup for shorts is reversed. In the recent case of June live cattle (LCM2: CME), notice how the pullback and resumption of the downtrend occurred at the 38.2% retracement of the previous downswing. This pattern is more effective if it takes place at a retracement level or is accompanied by single-bar patterns such as a tail, an inside (harami) bar or an outside (engulfing) bar.

Current Setups

Now let's move on to markets that have either just triggered or are setting up to trigger. July silver (SIN2: COMEX) is in day four of a pullback from its recent 20-day low. The trigger points for shorts are at the low of the high bar in a three- to seven-day pullback.

June dollar index futures (DXM2: NYBOT), a market that I suggested last week could pull back to the neckline of its head-and-shoulders pattern, are in day two of a pullback from their 20-day low. As with silver or any other pullback from a low setup, the trigger point is the low of the high bar in the pullback, three to seven days after the 20-day low.

July corn (CN2: CBOT) triggered on Friday, but Monday's slightly higher close is presenting a second opportunity to get short at the trigger -- the low of the high bar in the pullback -- in the 203 3/4 area.

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Marc Dupee is an independent trader and co-author of the book The Best: Conversations With Top Traders. Dupee was formerly markets analyst and futures editor for TradingMarkets Financial Group. At time of publication, he was short corn futures, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While he cannot provide investment advice or recommendations, he invites you to send your feedback to Marc Dupee.

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