The Definitive Guide to Pullbacks
Finding, Understanding and Trading J-hooks, Flags, Pennants,
Consolidations, Retracements and any other form of Pullback
including Trading Plans as well as
new and improved Scans for TC2000
By Ed Carter
© 2015 Ed Carter, all rights reserved.
First things first. I used the term Pullback in the title of this guide. However, “Pullback” can mean different
things to different traders. So before we get started, let’s put some definition behind the term.
What is a Pullback?
A Pullback trade setup is simply a temporary pause within a strong trend. It’s the consolidation or profit-taking
that relieve over extension and make a stock more attractive to enter than it was just prior to the pause. In short,
it’s the break in a rally that allows demand for the stock to build to a point where the supply/demand imbalance
causes the next leg of the strong move to start. In other words, Pullbacks are a necessary and healthy part of a
rally. Without them, once over-extended the demand for a stock would completely dry up and the rally would
collapse into a hard selloff / downtrend.
While a Pullback can happen in either a strong uptrend or downtrend, this guide
focuses strictly on the Uptrend or Bullish / Long setups. A separate e-book that
focuses on the Downtrend / Bearish / Short version will be produced later.
Since it is really nothing more than a temporary break within a strong rally, a Pullback can actually take many
different shapes and have numerous candle compositions and pattern names. Some of the more popular
Pullback patterns are the J-hook, Flag, Pennant, Triangle, Consolidation, Retracement, Measured Move, 1-2-3
Pattern, Fibonacci A-B-C Pattern, Elliott Waves 2-3 (or 4-5), etc. However, regardless of the small details like
what you call it, the key thing to understand is that the underlying cause, supply/demand characteristics and
market psychology behind all these types of pullback are the same. That being the case, the approach to
successfully trading all these different Pullback sub-types is also the same (or at least very, very similar).
So throughout this guide, I will use various sub-types of Pullback to illustrate my points. Where appropriate,
I’ll lay out the nuances that differ from sub-type to sub-type. However, those will be few and far between. The
vast majority of the guide will apply across all types of Pullback, regardless of name or the small variations in
chart shape.
With that all said, if you are more comfortable using one of the specific Pullback names, by all means go ahead
and mentally replace the term Pullback with your favorite as you read along. Whether you think of them all as
variations on a J-hook, Flag, Pennant or any other description, I promise you that the term you use and even the
small variations in chart shape will make no difference to the performance of these outstanding trade setups.
Introduction
In general, there are really only two basic approaches to trading. One approach is Trend Trading and the other
Reversal Trading. Neither approach is necessarily better, but each offers its own risk/reward profile.
Trend Trading focuses on finding an existing trend and riding it until the trend changes and the position is
stopped out. This approach might be seen as more conservative since the entry does not happen until a trend is
confirmed to be in place. However, the tradeoff for waiting on the trend confirmation is that some of the upside
potential is given up. In addition, it is the exit rules that will define whether it is a more conservative approach.
For example, if the trader waits for confirmation of an opposite trend being in place before exiting, most or all
of the gains from riding the original confirmed trend may be lost.
On the other hand, Reversal Trading focuses on spotting a reversal and getting in to ride the next move until
another reversal signal is seen. Some may see this as a more aggressive approach because the entry is made
earlier than a Trend Trade, before the trend has proven itself. Therefore, this approach will tend to have more
failed setups. However, when it does work, Reversal Trading will have considerably larger gains due to both
getting in and out earlier.
While it is often seen as a variation on Trend Trading, Pullback Trading is actually a combination of both these
approaches. Pullback Trading is essentially looking to ride a strong, proven trend by getting in on the reversal
from a pause back into the original strong trend. And since Pullback Trading is just a combination of the two
basic trading approaches, pretty much every trading system has a setup that intends to take advantage of
pullbacks for new entries or position additions. That's true regardless of timeframe, asset type, the primary
trading signal being used or even the indicators being employed.
In this guide, I'll explain the various forms a pullback can take, help you recognize and understand them and
then explain how they can be traded. Obviously, it will be impossible for me to cover all the potential
indicators that might be added to the basic trade plan. However, I'll give you the high-level view that should
allow you to refine the strategy as you make it your own. For some of you, especially newer traders, this will
be a very useful primer or refresher.
On the other hand, those who already have the basics of pullbacks down will still find a great deal of value in
the third section of the guide…how to find Pullbacks. In that section I'll cover how to create a scan that will
find more great Pullback setups than you'll ever be able to trade. This will include in-depth coverage of the
logic and code used in the brand new Pullback scan I've developed and tested over recent weeks. And yes, you
will be getting the scan formulas (or code) that you can simply copy/paste into the TC2000, ThinkorSwim or
Tradestation platforms.
Lastly, let me give a little organizational information about the rest of this guide. As mentioned above, this
guide will be devoted to Long (Bullish) patterns. It will contain three sections:
1) Recognizing and Understanding Pullbacks,
2) Trading Pullbacks
3) Finding Pullbacks.
This may seem out of order, but I'm making the assumption that the majority of readers will simply be
copy/pasting from the “Finding” section. So I stuck that section at the end to keep it out of the way.
With that explained, let's dive right in.
Part 1 - Recognizing and Understanding Pullbacks
Let's start with some definitions and examples of various forms of Pullback.
J-hook: Note the brief, sharp pullback that
quickly led to a flat trajectory. Thus it was a
tepid pullback that gave way to price starting
to revert to the original rally direction.
Flag: Note the well-defined and parallel
Highs and Lows of a tepid trajectory
pullback (relative to original strong rally).
Pennant: Note the flat trajectory of the
Lows trendline and descending Highs
trendline form a tepid pullback.
Triangle: Note the descending trendline
across Highs and the rising trendline the
Lows of this tepid pullback.
Consolidation: Not exactly a J-hook,
Flag, Pennant or Triangle…but definitely
a pause in a strong rally.
38.2% Fibonacci Retracement: Not exactly a
J-hook, Flag, Triangle or Consolidation…but a
tepid pullback retracing 38.2% of the rally.
In addition to the six names shown above, these types of pattern are also sometimes referred to
as “Measured Moves,” “1-2-3 Patterns,” “A-B-C Patterns,” (Elliott) “Wave Patterns” and/or
“Zig-Zag Patterns” (and probably several other names). The key take-away from all these
different names (for essentially the same pattern) is the fact that so many different schools of
trading have honed in on these setups. This is a good indication that the pattern works!
As you look at just those six examples, you’ll see that they each have slightly different shapes and sizes. They
are also make up of a wide variety of different size, shape and color candles. However, it is also clear to see
that in all six cases there was a strong rally that led to some sort of tepid pullback / consolidation. None of them
“fell down an elevator shaft.” So given the right signal and confirmation, each of them could be a great entry
into the resumption of the previous strong rally.
This is the key to Pullback Trading. It’s not the exact shape, candle composition or size of the Pullback that
matters. The important thing is that it is a tepid move (relative to the strong preceding rally) which indicates it
may well be just a pause before the strong trend resumes. In other words, as traders we are looking for Pullback
Patterns to be Continuation Patterns where they lead to a reversion to the mean (original strong trend).
Let’s break the Pullback down a little further.
Every type of chart pattern has to start somewhere. In the case of a Pullback, you need to have something to
pull back from. So the starting point is a stronger than normal uptrend. This brings us to our first important
sidebar.
Many traders (particularly those from a technical, detail-oriented background) pounce when they hear
descriptions like I just used (“stronger than normal uptrend”) with a burning desire to know EXACTLY
how that term is defined. (How many candles? What slope? Can there be any red candles? What
percent gain? etc., etc.) While this is a normal reaction, it's not productive in this case.
The truth is there really is no one-size-fits-all definition. There can be (and is) a lot of variation in the
strength and length of that rally. Even so, all those variants (that then form a Pullback) can be
successfully traded as long as the trader's own interpretation of the term matches that particular version
of “stronger than normal uptrend.”
For example, I know many traders who focus on hitting singles, so to speak. They are looking to
capture gains only over the next 3-4 candles. Their definition of “stronger than normal rally” is going
to be different from another group of traders who are only looking for trades with longer or larger
resulting moves (20-50% for example). And there are 1,000 shades of grey in between those two groups
as well. Yet all of them can find Pullbacks that fit their style and trade them very successfully.
So my advice is to not get bogged down in the minutia of strict definitions. Accept that there will be
variation and just look at the chart. Let your eyes tell you whether the most recent uptrend has been
strong relative to the rest of the price action you see. And if you're in doubt, just pass on that trade.
You'll find many more charts that leave no doubt. In short, just use your eyes and a little common sense.
With that term explained, we can just say the stock has been rallying stronger than usual.
As this happens, the market psychology in this stock starts to change. There will be a group of conservative
traders who start to feel the stock has risen “too far, too fast” for their taste and they'll start selling to take
profits. Another group of traders will be strict “indicator watchers” and once the stock gets into Overbought
territory (on the RSI, Stochastics or any other Momentum indicator they might favor), they too will start taking
off at least part of their position in order to lock in profits. There will also be those “micro-managers” watching
their position so closely that on the first down open they'll push the sell button.
Now these groups of sellers looking to take profits will be offset to some extent by the Johnny-come-lately rally
chasers, buying after they finally notice the stronger than normal move. (I'm sure none of us have ever done it,
but those are the traders buying in at a top…just before the stock turns down.) These folks will be aided by the
Bears (Short position holders) who, after a certain amount of strong rally, simply won’t be able to take the pain
of losing on their short and will buy to cover/close their position.
However, regardless of the Johnny-come-latelies and Shorts, at some point there will simply be more profittakers than there are new buyers showing up late to the rally (and willing to buy after a strong rally and at high
momentum indicator readings). At that point, we have more sellers than buyers and the stock will begin to
pause or pull back.
We need to note that this pullback behavior is perfectly normal and healthy for a rally. If nothing else, it gets
the "weak hands" out of the stock and brings this stock onto the radar of the pullback buyers (that's us).
As mentioned above, the pullback itself can take many forms, including many different combinations of candle
shapes, colors and numbers. It can also vary in terms of the depth of the pullback. Frankly, that perfectly
permissible variation in both the rally and the pullback is what makes it so difficult to build a good scan to find
Pullbacks. However, there are some broad, general guidelines that we can apply.
The first thing we should check is that the duration of the pullback has not lasted longer than the preceding rally
in terms of the number of candles. You can be lenient on this definition too, but the longer the pullback relative
to the rally, the less likely that pullback is a reaction to that original rally and the more likely it is a new trend
forming. For example, in an extreme case where you have a strong 3-day rally followed by a 15-day pullback,
I'd be very skeptical that the pullback is really just pressure relief for the rally. In a case like that, I'd suspect
any new direction (even a move back up) following the pullback is a new trend rather than a resumption of the
prior rally. So the bottom line is ideally we want some proportionality between the initial rally and pullback,
where the pullback is shorter in length (and more likely a reaction to the rally than a new trend altogether).
However again, just as with the preceding rally, there is no hard and fast definition that fits all Pullbacks such as
the pullback will be X candles in duration or Y percent deep. Again, it’s all about proportionality.
Perhaps a better way to explain this is to look at some examples of charts that don't qualify to help demonstrate.
The rally may fit the definition, but the
pullback was both too deep and too long
on this one.
Again, the rally was great, but the
pullback was too deep and perhaps
too long as well
Once again, the rally is great
(even with red candles), but
the pullback is way too deep
We'll contrast those examples of "non-qualifiers" with several more good Pullback examples in a moment.
However, before we do that, let's fill in some more of the broad, general description of the pullback to help you
recognize them.
The key characteristic of the pullback is that as it progresses, it will have signs of indecision or tepid sentiment.
That is, we want to see signs of the pullback losing steam (or never having much steam in the first place). We
don't want to see that there has been a clear and decisive change in trader sentiment in the Bear's favor. We're
looking for profit-taking and not the market selling hand over fist.
So we don't want to see large gap-downs and a lot of huge red candles that close near their low. Instead, we
want to see signs that supply and demand for the stock are really not tilted all that far in favor of the Bears (as in
the third example above). In other words, we're looking for some hesitancy among the sellers…clues that this
pullback is profit-taking. These clues could include any or all of the following:
- smaller candle bodies and larger wicks (both relative to the candles during the rally and in general);
- multiple Doji, Spinning Top, Hammers and Inverted Hammer candles;
- a flat and/or tight trading range;
- Trading staying within (or nearly within) the body of the last large candle of the pre-pullback rally;
- Both Red and Green candles in the pullback;
- A flattening or rounding of the pullback trend;
- The pullback ending at a previous Resistance (or previous Support) level;
- The pullback ending at a classic Fibonacci Retracement level (like 23.6% or 32.8% of the rally height).
The next characteristic we need to look for is the size of the pullback. Yes, I know that I said we can't define
the size of the pullback precisely, but we can give some general guidelines. And while some traders are more
lenient (aggressive) on this point, personally I never want to see the pullback retrace more than 50% of rally that
preceded it. I also strongly prefer pullbacks that do not exceed a 38.2% retracement.
I suppose my 50% retracement limit may simply be my personal bias since I use Fibonacci levels in my trading.
However, there is some logic behind my position. My reasoning is that any pullback greater than 50% shows
that the overall sentiment on the stock is not clear. In other words, the pullback is more than simple profittaking to relieve rally over-extension. At that size, it would be a significant move in and of itself. That being
the case, the market isn't really sure this stock should be (or should have been) rallying. Therefore, I can't trust
the next move up is actually a resumption of the rally, rather than just noise or a new trend altogether.
With those two characteristics laid out, let's look at several examples to illustrate some of these traits we are
looking to find in a pullback.
Note how this stock pulled back right to level that has acted as both Support and Resistance many times in the last year (Blue Arrows), as well as
an ascending Support line that has done the same several times in the last month (Blue Arrows). Then note that the low of the pullback was
smack on the 38.2% Fibonacci Retracement of the rally (Red Arrow).
Note the flattening trajectory and multiple
Doji and Spinning Top candles.
Note the tepid trajectory of the pullback,
long wicks and tight range.
This is more a consolidation than pullback,
but it too qualifies and the tepid trajectory
and multiple Doji / Spinning Top candles
show indecision.
Note the rounding trajectory and multiple
Doji and Spinning Top and Hammer candles.
Note the tight range of consolidation that has
stayed within the last large rally candle.
Again, here we have a flattening pullback,
multiple long wicks (especially to the
downside), multiple Doji / Spinning Top type
candles and the pullback has stayed in a tight
range (inside the last big rally candle).
As you reviewed those examples, what did you notice?
I noticed that the rallies were nothing alike and yet all were obviously strong rallies. The dollar and percentage
magnitudes were different. Some included large gap-ups, some very large up days and others just strong,
steady climbs. Some went unbroken, while others included down days and/or pauses. Regardless, the eye
shows us that all those stocks were indeed in a strong uptrend.
The next thing I noticed was that the pullbacks were also different…yet similar. They all had some indication
that the down move was not a complete change of sentiment on the stock, but rather showed signs of being just
profit-taking. In other words, some hesitancy showing the Bears don’t hugely outnumber Bulls, they just have
temporary control as the Bulls step away to take profit.
Those things being the case, in spite of the fact you'd call some of these charts Consolidations, others Flags,
maybe a Pennant or two, etc…they all represent the same market psychology and all contain the potential to be
great trade setups. In short, they are all variations on a pullback and should be traded very, very similarly.
One final point about the pullback. A common trait of pullbacks is that they will often form at least a small
base at their bottom. That is to say they will have two or more candles where the lows are near each other and
represent the bottom of the pullback. This is not a hard requirement of the pattern, but it is seen often. And
when we do see it, it's a good indication we are looking in the right place for a reversal back toward the original
rally trend.
Here are just a few examples of those bottoms.
Okay, let's recap. At this point we've recognized a strong rally and tepid pullback. We can also understand that
there can be variations in the pullback, with some looking more like Flags, others like Pennants and some the
classic rounded-bottom of a J-hook. In fact, some won't be pullbacks at all, but instead will be sideways tightrange consolidations. Regardless of the exact form, we will recognize that pullback hasn't been severe (it hasn't
exceeded 50% of the rally) and it has shown signs of weakness or weakening. Finally, we might see signs of
basing like two or more lows near the same level. At this point, we've almost got our setup!
Let's take a quick digression to talk about psychology again. Remember those traders that were nervous the
stock had moved too far too fast? Well, they’re out of the stock now. However, after seeing a few days of
weak pullback, it becomes apparent to the market that the stock is not going to go into free fall. This pullback is
obviously profit-taking. So those traders take comfort that most of the weak hands are now gone (even if they
themselves were part of the “weak hands” group) and they start looking for another possible entry. We’ve also
got another group, the dip buyers, looking for an entry as the pullback bottoms out.
So now, in a reversal of the situation when the pullback started, at some point the traders looking to buy will
outnumber the last of the profit-takers (and Johnny-come-latelies who are now being stopped out of the buy
they made at the rally top). When this happens, all we need is some sort of trigger or signal to push those on the
fence to buy, buy, buy! In other words all the market needs is some indication or confirmation that the pullback
is now reversing back toward the rally trend. That signal/trigger will cause the new demand to kick in and
reversion to the rally trend becomes a self-fulfilling prophesy. (As the stock price starts back up, every up-tick
brings it to the notice of more potential buyers looking to buy rally trends…another new set of buyers…and
every new buy causes another up-tick.)
Depending on a trader's style, that Setup trigger might come from a Candlestick Buy signal (such as a Bullish
Engulfing, Morningstar, Kicker, Best Friend or Left-Right Combo, etc.). For other traders, it will be a shortterm moving average cross (such as the 3ema crossing above the 8ema, etc.) Still other traders will be looking
for a sign from their favorite indicators, such as a line cross within the Stochastics, RSI or MACD oscillators.
Which one of these they focus on is less important than the fact that they see some indication (which they trust)
that the selling has abated and the Bulls are starting to take back control of this stock.
Let's look at some examples (just some, not an exhaustive list) of those potential Setup triggers.
* One thing to keep in mind, particularly with the candlestick signals is that the signal itself is not enough. We
need additional confirmation of the signal, such as a positive open the next day (or day after that).
That's it! That covers everything we need to recognize and understand up through the Setup. However, before
we go on to how we trade this (these) patterns, let's recap the components of a Pullback Setup one more time.
1) Stronger than usual/normal rally.
2) Tepid Pullback (relative to the rally).
3) Setup Trigger (Indication the pullback is over).
* Note this is an example of just one of MANY possible indications that the pullback has ended.
There you have it, everything you need to recognize and understand the Setup. So let's move on to trading it.
Part 2 - Trading Pullbacks
Trading Generalities
Every trader has their own style, which is a unique combination of trading signals, amount of confirmation and
aggressiveness of entry/stop-loss/exits that they use to trade. These many differences make it impossible for
any guide to provide a specific trading plan for every trader, even for a single setup pattern. However, we can
give some very good general guidelines that each trader can then modify with their own personal trading style
to create their trading plan for the pattern. These general guidelines are what I will lay out for you below.
There are two basic approaches (and one combination of the two) to trading any pullback, be it a J-hook, Flag,
Pennant, Triangle, Wedge, Consolidation, etc. Each of these approaches offers both some positives and some
negatives that may be seen differently by any given trader, depending on their frame of reference (personal
trading style). I don’t want to label these two approaches as aggressive or conservative, because in reality the
difference is more a matter of style than a difference in the level of risk taken. So for our purposes, I’ll simply
call these two approaches “Bottom Entry” and “Breakout Entry.”
As the names imply, one of these approaches is to enter the trade near the point that the pullback has bottomed
out. The other approach is to wait for the stock to break out above the pre-pullback high before entry. Neither
approach is “right” or “best.” Again, it’s matter of personal preference or trading style. That said, here are the
main characteristics of these two approaches:
Bottom Entry
1) Somewhat larger potential upside reward
2) Potential for small gain if breakout fails (if the position is managed tightly)
3) Less confirmation that the pullback has ended and a strong rally has resumed
4) The pullback base/bottom becomes support below the entry
5) Higher probability of a setup failure (failure to break back into original strong trend)
Breakout Entry
1) Somewhat smaller potential upside reward
2) No potential for small gain if breakout fails
3) More confirmation the pullback has ended and the original strong rally has resumed
4) The breakout level (pre-pullback high) becomes support below the entry
5) Higher probability of resumption of the original strong trend.
Of course, there is a third approach available. However, since this third alternative is just a combination of the
two approaches above, I will not cover this option in any depth. Suffice it to say that this third approach simply
involves taking both a Bottom Entry (perhaps with a smaller position size than the trader typically takes) and
then making a second Breakout Entry if/when the stock breaks out above the pre-pullback high.
Regardless of which approach we take, we can leverage one of the great things about trading Pullbacks…the
fact that they offer built-in support and target levels that many other setups don’t automatically offer.
In terms of support, the lows of the pullback form one line of support. There is also often either basing (which
allows a second line of support to be drawn across those base tops) or a top trend line (such as on Flags,
Pennants, Triangles, Consolidations and Wedges) which is a support line once crossed above. In addition, with
any pullback you can (and should) draw a line from the pre-rally low up through the pullback low. The
extension of this line makes another nice support line for the trade.
As far as targets go, because of the strong rally that preceded the pullback, every Pullback Setup gives us the
ability to use Fibonacci Extensions, Measured Move Theory and/and Pivot Points for targets (even if there are
no visible potential resistance levels above as we look to the left on the chart).
Trading the Pullback Bottom Entry
As I mentioned in the first section of this guide, in this setup we’ve had a strong rally, followed by a tepid
pullback. At that point, we saw a trading signal, which is then confirmed. Depending on our trading style this
confirmation may be of positive trading, a confirming indicator reading, etc. In my personal case, the signal
I’m looking for is a candlestick buy signal, confirmed by both positive trading the next day (or day after that)
AND a close above the 8ema (Trigger Line or T-line). However, your own style might use any number of
different confirmations, such as a Stochastic, RSI or MACD crossover, a moving average cross, etc. The
important point is that we’ve got a signal the pullback has bottomed and we have confirmation that we trust. At
that point, as a trader we are now we’re ready to go to work.
The next step to trading a pullback/consolidation pattern is to get our bearings. In other words, we need some
sign posts. So let’s begin by adding some to our chart.
In the example above we clearly have a rally much stronger than the 2-3 months of sideways trading that preceded the rally. We then
see a pullback that runs out of steam after a couple days and flattens. (Note that we had a couple lows at the same level.) Eventually we
see a Bullish Candlestick signal (Kicker type) that is confirmed by a gap-higher green candle and a second close above the T-line to
confirm the signal. (For users of other triggers, the Kicker day also had a 3ema x 8ema Bullish Moving Average cross and an unshown
Stochastics 12-3-3 %K x %D cross. Also not shown is that the low of the pullback was right at the 50% Retracement of the June rally
and less than 50% of the April-June rally.) This is the ideal setup for the Bottom Entry.
The guides or signposts we want to add to the chart include:
1) Potential Support
2) Potential Resistance
3) Gaps that might fill
4) Realistic Target prices (THESE ARE AREAS…not meant to be “to the penny” precise)
5) The price at which the future chart would be telling us the Setup/Trade had failed
6) The area where we would consider the stock a good buy right now (in other words, where a buy would
not be chasing the trade too much or buying a setup that has already failed).
We’ll use these various lines and levels as we develop a trade plan.
Note: Due to constrained real estate on the chart as they are shrunk down to fit in this guide, I won’t show these
all in one picture. However, normally I draw all these things on a single chart view (and in fact, write notes of
my entire plan for the trade right on that same chart view). That way I can grab a screenshot and add it to a
trade notebook. By adding a second screen shot of that same view at the end of the trade (with notes on results
added), it makes it very easy to go back later and review my performance (execution of the plan). In fact I can
go back to trades years later and get right back to exactly what I saw, was thinking and actually did to execute
the trade…and how that translated into results. (And do so without tying up precious brain cells I can no longer
spare for remembering every trade.) If you get nothing else from this guide, I can’t urge you strongly enough to
adopt this practice on every trade. I don’t know of any other tool that will help you improve more as a trader.
In this case, INSY is near all-time highs. Thus, when we look to the left we were unable to find higher levels of potential resistance.
However, we were able to add ascending Support lines, both in the Long and Short Term. There was also an Obvious Long-Term
Horizontal Support level (where the pullback stopped) and a Shorter-Term Horizontal Support where the Pullback based at the same
level as the highs from 6/11-6/13. We can also use the High that preceded the Pullback as a first potential Resistance / Target. Beyond
that we are left to use tools like Fibonacci Extension Levels, Pivot points or the “Wave 1 = Wave 3” (Measured Move) approach to set
targets. In this case, above I show a few key Fibonacci Extension levels to give us targets on which we can make decisions.
As mentioned above, we’ve got one useful Potential Short-Term Ascending Support Line (trend line) and one
Potential Short-Term Horizontal Support Level (about $35) not far below. We also have nice confirmation that
the level where the pullback bottomed out was both a Horizontal Support Level and the 38.2% Fibonacci
Retracement of the rally. That gives some extra confidence that this is a very nice setup.
The next thing we have to do is identify the “Buy Box” (the area where we consider the stock a good buy, a
price that would not be chasing a trade too late or entering a setup that is/has failed). Drawing this box is open
to interpretation (each trader will have their own value/risk function). However, ideally the bottom of this box
should be at a support level and the top of the box not too far above the confirmation day high. The reason for
this is that we want the bottom of the box to be at a level where if it trades below here, the chart is telling us the
setup has failed for now. At the other end, the higher we make the top of the box, the less potential gain we can
get if the trade fails at the previous high (first resistance), which means a lower initial reward/risk ratio on the
trade. So as I said, every trader will have to draw their own Buy Box, based on their Value – Reward/Risk
preference. However, to give you an idea, below is how I drew the Buy Box for this chart.
As you can see, here I have essentially drawn the Buy Box to encompass the Signal candle and the Confirmation Candle. Note that the
bottom of the box sits on both the Ascending Short-Term Support Trend Line and the 23.6% Fibonacci Retracement of the rally. A buy
anywhere in that box would give us at least a little support very close below and still leave a potential 12-18% gain just up to that
previous high (the breakout level / first resistance test). That would be a great buy in my book.
Okay, so now we know where we want to buy and we know the level below which we don’t want to own,
because trading down there would indicate the pullback is at least not yet ready to revert to a rally. Note that
another approach to helping size this box is to look at the stock’s Average True Range (ATR).
The ATR gives us a number that defines the stock’s average daily intraday move (or range). We definitely
don’t want the bottom of the box (and our initial Stop-Loss setting) to be within 1 ATR of our actual buy price.
We can’t expect trading to go up all day without any intraday swings after we buy. We have to acknowledge
that the stock needs a little room to work. So setting a stop tighter than 1 ATR below entry is just begging to be
stopped out prematurely.
We’ve also got an initial target (first resistance or previous high). Above that we’ve got some rough target
areas that have some logic behind them, but we can’t be as confident as if they came from resistance/support
levels defined by previous trading. Those higher target areas are not ideal, but we can certainly work with them.
In fact, I’ve found Fibonacci Extension levels work very well, especially when the pullback also respected a
Fibonacci Retracement level.
However, before we write up that trade plan, let’s look at a scary day that happened two days later and confirms
the value of building your Buy Box with Support below.
Note that above we were just able to get in the next day, because we had a gap-up and trading at the top of and
above the Buy Box. Had we waited, we could have gotten a better price the next day. However, let’s look past
that and consider the Buy Box size.
If we used a smaller Buy Box (moved the bottom of the box up), we would have been stopped out when the
stock went down to test the ascending support the day after entry. (And unless we had the courage to get right
back in, we’d have missed the rally the rest of that day, let alone the potential of the pattern.) On the other
hand, if we had made the Buy Box larger (raised the top) we may have bought at a higher price and might have
had to sit through a major potential loss on that scary day. The box we drew was plenty scary enough at the
time that ascending support was being tested.
The important take-away here is that the Buy Box has to encompass what we can emotionally handle as traders.
So ask yourself three questions.
1) At what price am I going to kick myself for paying too much (chasing) for an entry?
2) If I enter at the top of the box, how much loss (pain) can I handle before I’ll bail out with a loss?
3) What (potential support) gives me some confidence that level won’t be breached?
There is no “one size fits all” Buy Box, but answering those three questions is how you can build one that is
custom fit to your trading personality.
At this point we have everything we need to create a Trade Plan for INSY. So let’s take a look at what that plan
should include and what it might look like for this example trade.
Example Trade Plan for INSY using “Bottom Entry”:
Pattern:
Setup Trigger:
J-hook Pullback
Confirmed Bullish Kicker type with 3ema x 8ema cross and 2 Closes above T-line
Buy Box:
$36.30 - $38.15
Initial Stop:
$36.19 (38.2% Fibonacci Retracement and not far below Signal candle Open)
First Target:
$42.69 (Pre-hook High) which is between 11.9% and 17.6% of Buy Box extremes
st
Action at 1 Target: Raise Stop (some traders would take all/part of their profits off the table here)
1st Risk Profile:
Risk =
5.1% ($38.15 buy / $36.19 stop)
Reward =
11.9% ($38.15 buy / $42.69 target)
Minimum Reward / Risk Ratio = 2.33 to 1
Risk =
0.3% ($36.30 buy / $36.19 stop)
Reward =
17.6% ($36.30 buy / $42.69 target)
Maximum Reward / Risk Ratio = 58.67 to 1
Note: This trade is so strong I won’t even list the Risk Profile at other targets and would not use
them for decision-making anyway. Those can be calculated later. If the trade had smaller
Reward/Risk ratios, I’d add and consider the ratios at the second target as well for
deciding whether to take this trade.
Second Target:
$46.71 (23.6% Fib Extension of pre-hook rally) +22.4% to +28.7% of Buy Box
nd
Action at 2 Target: Take 50% of position off and Raise Stop (percent taken is an individual choice)
Third Target:
$49.19 (38.2% Fib Extension of pre-hook rally) +28.9% to +35.5% of Buy Box
Action at 3rd Target: Take 25% of position off and Raise Stop (percent taken is an individual choice)
Last Target:
$53.21 (61.8% Fib Extension of pre-hook rally) +39.5% to +46.6% of Buy Box
th
Action at 4 Target: Take 25% of position off and Raise Stop (percent taken is an individual choice)
-orRaise Stop and ride until stopped out.
Trade Expectations: I do not expect this trade to go straight up. I expect profit-taking days (or intraday
moves) along the way. Could it make a meteoric straight-up move? Sure, but I don’t
expect one. These pauses/consolidations/profit-taking days will be particularly expected
at/near each resistance level. So I’m looking for a jagged line move higher. As long as
we are not violating the Short-Term Ascending Support Line or my trailing-stop, I will
let the trade work. Of course, this plan may be changed if the overall market goes into a
strong downtrend or I see a strong sell signal that is confirmed.
I do want to offer a couple side notes about this trade plan.
First, you’ll notice that at each Target I specified “Raise Stop” as an action. This is just one possible approach.
Personally, I enter a “Trailing Stop” on my trades. So I set an initial Stop-Loss price and as the price of the
stock increases, my Stop-Loss prices rises as well (penny-for-penny). Since I use this type of Stop-Loss order,
it’s even more important that I take the stock’s ATR into account. The reason it’s an even more important
consideration is that on any large range day that closes near the low, the trailing stop will have been raised (by
that day’s new high). However, the stock’s normal daily range will still be in effect the following day. This
means you would be more likely to be stopped out on the day following a close near the low. That’s true even
if that day is only an average range day and the stock actually ends the day higher.
So for example, let’s say a stock is at $10, it has an Average Daily Range (ATR) of $1 and I enter on the close.
If I enter a Trailing Stop at 0.5 ATR below entry price, it is initially set at $9.50. The next day the stock goes as
high as $11, but closes at $10.51. My Trailing Stop was raised to $10.50 by the move to that $11 high. And
while I was lucky not to get stopped out that first day, I will be stopped out the second day unless the entire
daily range is to the upside that next day. I would not have even one tick of slack before that tight 0.5 ATR
Trailing Stop was triggered.
For that reason, I tend to use at least 1.5 ATR as the distance below entry and adjust that based on support levels
I see on the chart. Some people cringe at the thought of a stop set that loose. That’s okay. Every trader has to
find an approach that works for their own risk tolerance. In my case, I see being stopped out early as a risk too.
And that is one risk I can avoid by accepting a looser Stop. So I find a looser stop is an acceptable approach
when I really have confidence in the setup and there are support levels below. Your mileage may vary…so
make your own decision based on your personal Risk/Reward function.
The second point about this Bottom Entry Trading Plan is that if you were trading a Flag, Pennant, Wedge or
Triangle pattern instead of the “J-hook” shown in the example, you would use exactly the same approach to
trading the Bottom Entry. In those cases, the Buy Signal that triggers an entry would be a confirmed move
through the down-sloping trend line that forms the top of the pattern. However, the reasoning behind a Bottom
Entry, the process of planning the trade and the trade plan itself would be identical. (Note: There are no
“Bottom Entries” for a flat/sideways consolidation. That particular variant of Pullback must be traded using the
Breakout Entry.)
I know some of you may be skeptical on this second point. And while I won’t go through detailed examples of
each (Trade Plans), I can provide some marked-up Trade Setup Charts to illustrate the point.
And there you have it. That is how you can successfully trade a Pullback Bottom Entry. It’s really not that
complex or difficult once you get a few repetitions under your belt.
Trading the Breakout Entry
As I mentioned in the first section of this guide, in this setup we’ve had a strong rally, followed by a tepid
pullback. At that point, we saw a trading signal, which is then confirmed by a Close above the pre-Pullback
High. Again, as with the Bottom Entry, the initial Setup signal could be any number of Bullish trading cues
such as an Bullish indicator reading, a moving average cross, a confirmed candlestick buy signal, etc. However,
the important point is that we have a signal the pullback has bottomed out and now we have confirmation of a
breakout back above the start of the pullback. Let’s look at a couple examples where we’d be tempted to enter,
but don’t quite have the breakout confirmation we need to take the trade just yet.
In both these cases, we would have been sorely
tempted to enter near the high of the last candle.
However, neither of them closed above the prepullback High. In fact, although coming close
intraday, neither of them actually even traded
above that level. So while inviting, we need to
pass and wait for the confirmation.
Now let’s look at a few examples of good Breakout Entry confirmations.
Again, as you can see in all three of these examples we would have been sorely tempted to enter on the next to last candle near the high of that day’s
range. However, we needed to wait until we were sure that last candle was going to close above the breakout level. We might enter at the end of the
day, if Closing above looks to be a sure thing. However, we could also wait until the next Open. Doing the latter gives up any gains from an overnight gap up, but also gains the confirmation that this wasn’t just a 1-day test of the breakout level.
The point of waiting for a Close above the breakout level is the conversion of that level from resistance into
support. Until we close above that level, at best we are testing it as Resistance. However, once we close above
it, that level becomes support. And having support just below our entry makes safer and more confident
trading. In other words, that extra confirmation of direction and new support level below ought to give us the
additional confidence we need to allow a retest of that breakout level to work itself out without bailing out of
the trade too early.
However, let’s not get ahead of ourselves. As with the Bottom Entry, in order to plan this trade we are going to
need to get our bearings…some sign posts if you will. So let’s grab an example and add some of those guides
to our chart.
It’s a little tough to see, but ELNK closed above the B/O Level, had a Buy Box of $4.34 - $4.54 and targets defined by a Daily Resistance Level
($4.87), Fibonacci Extension Levels (38.2% = $5.01, 61.8% = $5.36) and a Weekly Resistance Level ($5.52). Using these inputs we’re ready to
analyze the trade setup and create a trading plan.
As you can see above, we started by looking to the left. Note that the Breakout Level was also the Swing-High
a few months prior to this rally. That means it’s a significant resistance level and must be respected. Therefore,
the logic of waiting for a close above (and then expecting a retest of) that level makes a lot of sense. In
addition, by looking to the left we identified two strong Resistance Levels above. (One of them is labeled “from
Weekly Chart” but it was a multiple-touch Daily resistance. I needed to use the Weekly chart in order to get
enough data to see those touches further back in the past than TC2000 allows Daily data.)
We also drew an Ascending Support Trendline that has had six touches so far. And for good measure, we
added a Line where the Pullback had multiple nearly identical Lows (support) as well as adding Fibonacci
Levels as additional potential targets.
As with the Bottom Entry (or any trade setup), we now need to create a Buy Box. This box has to encompass
what we can emotionally handle as traders. So again, we ask ourselves three questions.
1) At what price am I going to kick myself for paying too much for an entry (chasing)?
2) If I enter at the top of the box, how much loss (pain) can I handle before I’ll bail out with a loss?
3) What (potential support) gives me some confidence that level won’t be breached?
There is no “one size fits all” Buy Box, but answering those three questions is how you can build one that is
custom fit to your trading personality.
In this case, I chose a Buy Box with an upper boundary of $4.54 (not far above the breakout candle’s high) and
a lower boundary of $4.34 (just below the breakout candle’s low). You can’t tell in the image above, but trust
me when I say the bottom of the Buy Box just grazes the Ascending Support Trendline and matches the highs
of the next to last day of the original rally and the third day of the pullback.
That provides about a 4.6% range within the box, which should do very nicely for a Breakout Entry. Remember,
on a Breakout Entry like we have here, the stock has already run up 7.66% over the last 3 days. So we might
suspect a little trading below the Breakout day’s close and at least a retest of the Breakout Level to be coming
the next day. To make this a little more clear, below is a closer view.
With the Buy Box chosen, let’s lay out the rest of our trading plan and see if this trade makes sense.
Example Trade Plan for ELNK using “Breakout Entry”:
Pattern:
Setup Trigger:
J-hook Pullback
Multiple matching Lows with a 3ema x 8ema cross, 3 Closes above T-line and 1 Close
above the Breakout Level
Buy Box:
$4.34 – $4.54
Initial Stop:
$4.31 (T-line on Breakout day and not far below Signal candle Low)
First Target:
$4.87 (Daily Resistance) which is between +7.3% and +12.2% of Buy Box extremes
Action at 1st Target: Raise Stop (some traders would take part of their profits off the table here)
1st Risk Profile:
Risk =
5.3% ($4.54 buy / $4.31 stop)
Reward =
7.3% ($4.54 buy / $4.87 target)
Minimum Reward / Risk Ratio = 1.38 to 1
Not enough Reward to justify trade
Risk =
0.7% ($4.34 buy / $4.31 stop)
Reward =
12.2% ($4.34 buy / $4.87 target)
Maximum Reward / Risk Ratio = 17.42 to 1
Very, very good ratio!
Second Target:
$5.01 (38.2% Fib Extension of pre-Pullback rally) +10.4% to +15.4% of Buy Box
Action at 2nd Target: Take 50% of position off and Raise Stop (percent taken is an individual choice)
Third Target:
$5.36 (61.8% Fib Extension of pre-Pullback rally) +18.1% to +23.5% of Buy Box
Action at 3rd Target: Take 25% of position off and Raise Stop (percent taken is an individual choice)
Last Target:
$5.52 (Weekly Resistance Level) +21.6% to +27.2% of Buy Box
th
Action at 4 Target: Take 25% of position off and Raise Stop (percent taken is an individual choice)
-orRaise Stop and ride until stopped out.
Trade Expectations: I do not expect this trade to go straight up. I expect profit-taking days (or intraday moves
along that way. Could it make a meteoric straight-up move? Sure, but I don’t expect one. These pauses/profittaking days will be particularly expected at/near each resistance level. So I’m looking for a jagged line of climb
higher. As long as we are not violating the Short-Term Ascending Support Line or my trailing-stop, I will let
the trade work. Of course, this plan could be changed if the overall market goes into a strong downtrend of I
see a strong sell signal that is confirmed.
Note: This trade really depends on the entry price we can get. At the top end of our Buy Box the
Reward/Risk simply is not there to justify a trade…at least if only considering the first target. So
if we took the trade with an entry at the top end of the Buy Box, we would be counting on the
stock reaching at least the second target to make the Reward/Risk Ratio acceptable. However, if
we can get an entry price closer to the bottom of the Buy Box, the Risk Profile is strong, even at
just that first target. This one is all about the entry!
I want to offer a couple notes about this trade plan.
First, as with the Bottom Entry, you’ll notice that at each Target I specified “Raise Stop” as an action. This is
just one possible approach. Personally, I enter a “Trailing Stop” on my trades. That means that it is set an
initial Stop-Loss price the Stop Price increases penny-for-penny every time the stock price moves up from
where it was at the time the Trailing Stop was set. Since I use this type of Stop-Loss order, it’s even more
important that I take the stock’s ATR into account. The reason it’s an even more important consideration is that
on any large range day that closes near the low, the trailing stop will have been raised (by that day’s new high).
However, the stock’s normal daily range will still be in effect the following day. This means you would be
more likely to be stopped out on the day following a close near the low. That’s true even if that day is only an
average range day and the stock actually ends the day higher.
So for example, let’s say a stock is at $10, it has an Average Daily Range (ATR) of $1 and I enter on the close.
If I enter a Trailing Stop at 0.5 ATR below entry price, it is initially set at $9.50. The next day the stock goes as
high as $11, but closes at $10.51. My Trailing Stop was raised to $10.50 by the normal action of the stocks
daily range. And while I was lucky not to get stopped out that first day, I will be stopped out the second day
unless the entire daily range is to the upside. I would not have even one tick of slack before that tight Trailing
Stop was triggered.
For that reason, I tend to use 1.5 ATR as the distance below entry and adjust that based on support levels I see
on the chart. Some people cringe at the thought of a stop set that loose. That’s okay. Every trader has to find
an approach that works for their own risk tolerance. In my case, I see being stopped out early as a being a risk
too. And that is one risk I can avoid by accepting a looser Stop. So I find a looser stop an acceptable approach
when I really have confidence in the setup and there are support levels below. Your mileage may vary…so
make your own decision based on your personal Risk/Reward function.
The second point about this Breakout Trading Plan is exactly the same plan we’d use if trading a Flag, Pennant,
Wedge, Triangle or Sideways Consolidation pattern instead of the “J-hook” shown in the example. In all those
cases, the Buy Signal that triggers an entry would be a confirmed by a Close above the Breakout Level. The
only difference among the various sub-types of Pullback would be the point that defines the Breakout Level. In
a J-hook, Flag, Pennant Wedge or Triangle, the Breakout Level would be the High at the beginning of the
Pullback pattern. In the case of a Sideways Consolidation, it would be the High of that sideways period.
However, otherwise the reasoning behind a Breakout Entry, the process of planning the trade and the trade plan
itself would be identical.
I know some of you may be skeptical on this second point. And while I won’t go through detailed examples of
each (Trade Plans), I can provide some marked-up Trade Setup Charts to illustrate the point.
And there you have it. That is how you can successfully trade a Pullback Breakout Entry. As with the Bottom
Entry, it’s really not that complex or difficult once you get a few repetitions under your belt.
Part 3 - Finding Pullbacks
Scanning Generalities
Designing, writing and testing a good scan is a difficult task. The scan creator will always face a basic choice.
You can make the scan criteria very tight. In that case, you will eliminate more of the “bad hits.” However,
you will also miss a lot of potentially “good hits.” On the other hand, you can make the scan criteria loose. If
you take that approach you’ll get a lot more of the “good hits,” but you’ll also get a lot more “bad hits” mixed
into the results. It’s a very delicate balancing act that is complicated by the fact that markets change every day
(the ratio of “chaff to wheat” from every scan will vary as market conditions vary).
This basic dilemma becomes exponentially more difficult when the definition of a “good result” fluctuates or is
not strictly defined. And unfortunately, that is exactly the case with pullbacks where a “good hit” can:
- Take various shapes and have varying candle compositions;
- Last varying lengths of time, both absolutely and relative to the pre-pullback rally;
- Have varying depths, both in absolute dollars/cents and in percentage terms;
- And all of this follows a rally of varying size, slope, candle composition and duration.
This makes scanning for pullbacks an extremely difficult task. So before we get deep into the weeds of how we
find Pullbacks, I want to set some expectations. The scan I’m about to show you will not find EVERY pullback
in the market. In addition, every result will not be a great pullback example. In fact some days, you’ll be
frustrated that many results don’t seem to fit what you seek or some other trader will point out a great pullback
that the scan missed. You’ll just have to accept the fact that no scan is perfect.
That said, I have built a scan that does an excellent job of finding all the various types of pullback and does so
with a minimum number of “bad hits” making it through into the result lists. In my testing, about 80% of the
results met one of the major definitions of a pullback/consolidation. While your results will vary (as market
conditions change from the weeks that I tested the scan), in general I’d expect you to get roughly the same ratio
of chaff/wheat. Of course, if you are looking for only one specific size, type of stage of pullback you’ll find far
fewer of what you personally consider a “good hit.” In any event, this scan will certainly find more great setups
than anyone can ever trade.
With those expectations set, let’s move on to a second preliminary topic we need to cover. In the last paragraph
I mentioned that this scan will find all the various sub-types of bullish pullback. Due to the similarities of the
various sub-types of pullback and the complexities of finding a complex pattern it is not practical to break these
results into sub-pattern groups. In other words, the results will contain a mixture of J-hooks, Flags, Pennants,
Triangles, Consolidations and every other type of bullish pullback. The reason that can’t practically be broken
into sub-groups is that the various chunks of code that make up the scan each finds a mixture of results. So one
chunk may find a lot of J-hooks, but it also finds a good number of Pennants and Flags. Another chunk finds
mostly Flags, but it too finds J-hooks, Pennants and Consolidations. So the results will be a mixture and it will
be up to each trader to review the results and pick out the best examples of the pattern they are looking to trade.
The good news is, as I’ve stressed above, all these sub-types of pullback can be traded very similarly and all can
offer excellent results. So the results will give each trader a chance to branch out just a bit, while staying within
the confines of trading a trend continuation pullback opportunity.
The next topic we should address is analysis of the scan results. Specifically, the issue is that traders (especially
newer traders) “see what we want/expect to see.” What I’m referring to is that each of us comes from a distinct
trading background. As I mentioned early in this guide, some traders look for J-hooks every day. For other
traders Flags or Pennants is their wheelhouse. Still others focus on Consolidation, Wedges, Triangles, etc. etc.
These varying experiences impact the patterns that we recognize most easily. As a result, given any list of 10
scan results, one trader is likely to say “that’s 7 J-hooks of various stages and three others.” At the same time,
another trader will look at the same list and say “Nope, that’s 8 Flags of various stages and 2 others.” A third
trader will say “you guys are nuts…that’s 5 Pennants, 3 Consolidations, a Flag and a bad hit.”
The point is, as you go through the results of this scan you’re likely to see some patterns more easily than
others. As a result, you may think the scan is skewed to find one more than others. That’s not the case at all,
but it is easy to feel that way. This impression will be intensified by the fact that simply based on the changing
market there will be some days there simply are a lot more Flags or Pennants or J-hooks or Consolidations than
the average day…and perhaps even more than most other pullback types.
This is part of the beauty of a combination scan like this one. As I said, all the major pullback sub-types offer
good potential (if they meet our setup criteria) trade setups. So on days when there are very few good Pennants,
this scan will find us J-hooks, Flags, Consolidations and other pullback patterns to trade. A week later there
may not be any nice J-hooks or Consolidations, but the scan will find us plenty of great Pennant setups. In that
way, no matter what the market does the scan will find nice trade setups. Think of it this way. It’s like a hunter
heading out to find food. If the hunter says “I’m going to bring back some sort of meat, fish or foul to cook for
dinner” they have a much higher chance of success than the hunter whose plan is “I’m only going to bag a 10
point or greater, buck, albino deer weighing between 250 and 300lb.” The first hunter has an excellent chance
of bringing home dinner. The second hunter has an excellent chance of having many hungry nights between
successful hunts.
So, the mixed pullback results are really a strength of this scan. As I’ve shown in the earlier sections, all
Pullbacks make for good potential trade setups. In addition, many charts fit more than one (sometimes several)
pullback sub-type definitions at various stages of development. The point is, don’t let the fact you seem to be
seeing only your favorite throw you. Over time, you will start to recognize the other types of pullback among
the results just as well as you make out your current favorite. Until then, draw the pattern on the charts. You‘ll
learn to see all the patterns more quickly and in the meantime you’ll be able to make very good money just
trading your favorite.
Okay, now on to the meat of the subject.
Specifics of the Pullback Scan
This is one of the most complex scans I’ve ever written. This is due to all the variability in the definition that
we just discussed. First, the “strong rally” can be various sizes both in terms of the number of periods and in
terms of the height (both absolute dollars/cents and in percentage terms). Second, the pullback itself can differ
in shape, length, height and candle composition.
Because of this complexity, I’ve decided not got go through and explain the logic behind each and every line of
code. Otherwise, this would turn into a “How to program” syntax guide rather than one on pullbacks. Instead I
will lay out the criteria used in this scan (in plain English), section by section of the scan. Hopefully this will
give those of you interested in the logic enough understanding to work with the code – or me – to improve it
even further down the road.
General Criteria:
1) Enough Liquidity
There are many ways to tackle this issue, I chose to use the 3month (63 trading days) Average Volume
multiplied by today’s Current/Closing Price and require that to be more than $1,000,000. My logic is
that if a stock trades at least $1million in stock on an average day then the vast majority of retail traders
can get in/out of any position they take with no trouble. (In other words, they won’t have to pay up for
an entry or take less for an exit just to get in/out quickly.) If you prefer a different amount of liquidity,
simply change that 1000000 to some other number (2000000, 5000000, 10000000, etc.).
2) The Rally was Big Enough
This criteria might vary depending on your trading horizon. If you are looking for quick, in/out type
trades that last a couple days, you may find smaller pre-Pullback rallies work just great. Other traders
looking for bigger moves will probably want the pre-Pullback rally to be larger. In testing, I found the
sweet spot (to my eye) was in the 12%-15% range. If you require any less than “at least 12%” gain in
the pre-Pullback rally, I’ve found you start getting too many hits from the scan (and many of those hits
will have smaller post-pullback moves. However, if you increase the required minimum pre-pullback
rally size above 15%, you start severely limiting the results the scan finds. So initially, I have set the
scan to a default of at least a 12% pre-pullback rally. However, as with the liquidity, you can change
that to any percentage you want to try.
3) Pullback Was NOT Severe
This one is a little more complex. The basic idea is that we are looking to make sure that the pullback
was less than 50% deep, relative to the original rally. However, we have to make this check without
knowing exactly how tall the original rally was (either in percentage terms or number of candles) or how
far into the pullback we are now (how many candles into the pullback). So, without getting into the
mechanics, we have to use some assumptions and a little fancy code. However, if you wanted to loosen
(perhaps to allow pullbacks of up to 60%) or tighten (say to less than a 30% pullback), all you have to
do is change the multiplier factor from “0.5” to your preferred allowable percentage.
4) The Pullback is At/Near its End
a) One way to improve the odds that the stock is no longer falling (at least hard) and the pullback is
basing/bottoming out is to require that the current candle Close is greater than one of the last two
candle’s Lows. If we require that the current Close was above the previous Close the criteria would
be too restrictive and would eliminate many nice setups. However, requiring the current Close to
just be above either of the last two Lows gives each stock a little slack while still telling us the result
stocks are at least not falling hard.
b) The second approach to finding stocks that have pulled back, but are now starting to revert back to
their previous pre-pullback uptrend is to look for a short-term uptrend. And one of the best ways to
identify a short-term uptrend is for the Current/Closing price to be above the 8ema (or T-line). So
this scan weeds out any pullback that is not currently trading above its T-line.
5) We Have Not Missed the Pullback Opportunity
The whole idea of this setup is to trade a pullback, rather than chasing a breakout or trend in progress.
So this criteria is meant to ensure that the stock has not already broken out of the pullback and started to
run away from us. To do this we require that the previous Close (not the current price/Close, the Close
prior to the current candle) is below the Pre-Pullback High. Pre-Pullback High refers to the highest
High of the 20 days ending 2 days ago.
That’s it for the general criteria. The remainder of the scan gets into finding various specific sub-types of
Pullback.
Pullback-Specific Criteria:
1) Pennants
Pennants are defined by the strong pole (we already made sure we have the pole in the general criteria)
and then a decreasing difference between the highs and lows following the pole. The tricky part here is
that we don’t know how many days the pennant has already been underway. However, I made the rough
assumption that it has to have been underway for at least 4 candles. So I compare today’s High-Low
range to the average High-Low range of the last 3 days. Then I compare the average High-Low range of
the last 3 days to the average High-Low range of the 6 days prior to 3 days ago. If both comparisons
show the High-Low range is decreasing, this is likely a Pennant Pattern.
2) General Pullbacks
There are a lot of stocks whose chart has a pullback, but it just misses qualifying under any of the other
specific Pullback sub-type criteria. These can include many very nice “W” patterns, Double Bottoms,
etc. but they just don’t quite qualify as ideal J-hooks, Flags, Pennants, etc. The idea of this set of criteria
is that we catch those pullbacks as well (as long as they also meet the general criteria). To do this we
use a mechanism similar to the last General criteria. In this case we require that one of the last two
Closes is below either the Highest Open or the Highest Close of the 20 days ending 2 days ago. Since
we already know stocks that qualify have rallied at least 12% prior to the pullback, by definition this
finds us pullback setup candidates.
3) Flags
One way to find Flag patterns is to use exponential moving averages. After considerable testing I found
that the 3-period EMA worked pretty well for this task. What the scan does is compare the current 3ema
to the 3ema 5 days ago. If the current one is below the older one then there is a decent chance we are
seeing a Flag form. We can increase he probabilities it is a good flag by also looking for volume that is
decreasing during the flag period.
4) Pullback Variation
Another way to define a general pullback patterns is to use Highs and Lows. This section compares the
Highest High of 6 days from 4 days ago to the High 4 days ago. If the latter is more than 10% higher
than the former and the Lowest Low of 6 days from 4 days ago is also at least 5% less than the Lowest
Low of the last 4 days, then a nice pullback is usually in progress.
5) Pullback Variation #2
Another way to find pullback patterns is a variation of the last two approaches, but comparing more
recent periods to a period 8 days ago…as opposed to 4 or 5 days ago in sections 3 and 4). It combines a
comparison of 3-period EMA with a look at the Lowest Low and Highest High of the last 3 days to their
value 8 days ago. It then also requires lower volume during the pullback as we did in section 3 above.
6) Consolidations
The last section of our pullback logic is specifically looking for consolidations. In this case, remember
that the general criteria already ensure there was at least a 12% rally recently. So in this section we are
looking to make sure that over the last 10 days the Lowest Open and Lowest Close are within 10% of
the Highest Open and Highest Close. We also require at least a 1% variation in those values because
testing has shown that when a stock has a big rally that results in tiny, tight consolidations (dead flat,
small-body candles), that consolidation can last a long, long time. So using the 1%-10% requirements,
we find our ideal post-rally consolidations.
That’s it for the pullback-specific criteria. In fact, that’s it for the logic of the scan. All the remaining code (in
the ThinkorSwim and Tradestation versions) is focused on allowing user-changeable variables and displaying
the scan results.
TC2000 Version:
In this section I will first provide the code for the TC2000 pcf (Personal Condition Formula). Below that I’ll
provide instructions for installing the scan for those who need it. Finally, I’ll cover a few modifications you can
make if you’d like to experiment with variations of the scan.
Code for PCF:
( AVGV63 * C >= 1000000 AND
( MAXC5.4 / MINC30.4 >= 1.12) OR ( MAXC5.5 / MINC30.5 >= 1.12) AND
( MINC5 >= MAXC20.5 - ( (MAXH20.5 - MINL30.5) * 0.5 ) ) AND
C >= XAVGC8 AND
( (C > L1) OR (C > L2) ) AND
C1 <= MAXH20.2) AND
( (H - L) < (AVGH3 - AVGL3) AND
(AVGH3 - AVGL3) < (AVGH6.3 - AVGL6.3) ) OR
( ( (C1 < MAXC20.2) OR (C1 < MAXO20.2) ) OR
( (C2 < MAXC20.2) OR (C2 < MAXO20.2) ) ) OR
( XAVGC3 < XAVGC3.5 AND
AVGV3 < AVGV3.5 AND
MAXV5 < MAXV5.5 ) OR
( MINH6.4 * 1.10 < H4 AND
MINL6.4 * 1.05 < MINL4 ) OR
( XAVGC3 < XAVGC3.8 AND
MINL3 < MINL3.8 AND
MAXH3 < MAXH3.8 AND
AVGV3 < AVGV3.5 AND
MAXV5 < MAXV5.5 ) OR
( ( (MAXO10 - MINC10) > C * 0.01 AND
(MAXO10 - MINC10) < C * 0.1 ) AND
( (MAXC10 - MINC10) > C * 0.01 AND
(MAXC10 - MINC10) < C * 0.1 ) AND
( (MAXC10 - MINO10) > C * 0.01 AND
(MAXC10 - MINO10) < C * 0.1 ) AND
( (MAXO10 - MINO10) > C * 0.01 AND
(MAXO10 - MINO10) < C * 0.1 ) )
That is the code. Simply highlight and copy then paste it into a TC2000 pcf. Then run the pcf as an Easyscan.
Step-by-step instructions for installing the scan in TC2000 (version 12):
1) Copy the code above.
2) In TC2000 (Version 12.x), click the Library menu and choose Conditions.
3) The click on “New Condition Formula”
4) In the resulting pop-up box, add a title and click in the body, then paste the code you copied in step #1.
Click OK to save the work.
5) From the resulting list, find you new condition and click the little orange lightening/arrow to the right of the
name.
6) The scan runs and pops up a results list. On that list, click on the Edit tab and change the “List to scan” to
the universe you want to scan (for example, US Stocks)
7) Then click the scan tab to get your results. When you’ve reviewed the list, click the X in upper right hand
corner o list to close, but be sure to save the scan under a name (like the same name you used for the
condition).
8) The next time you want to run the scan, you can now select it from the Main menu Easyscans section.
Scan Modifications for Liquidity, Rally and Pullback:
1) Enough Liquidity
If you want to adjust the amount of liquidity the scan requires (as defined as the 3mo average daily
volume multiplied by the current Price/Close), all you need to do is modify the first line of code. This is
how the first line looks now:
( AVGV63 * C >= 1000000 AND
As an example, perhaps I only want stocks that have an average daily liquidity of $2.5 million. To do
this, I would simply change that line of code to read:
( AVGV63 * C >= 2500000 AND
That’s it. Make that change, resave and then repeat Steps 5-8 from the scan installation instructions.
2) The Rally was Big Enough
As I mentioned earlier in the guide, to my eye the sweet spot for the size of the pre-Pullback rally is in
the 12-15% range. The scan is set to a default of finding stocks that rallied at least 12% prior to their
pullback. However, if you want to experiment, all you need to do is modify the second line of code in
two places. This is how the second line looks now:
( MAXC5.4 / MINC30.4 >= 1.12) OR ( MAXC5.5 / MINC30.5 >= 1.12) AND
As an example, let’s say we want to require a 20% rally before the pullback. To do so we just change
the two “1.12” numbers to read “1.20”. That line of code would then read:
( MAXC5.4 / MINC30.4 >= 1.20) OR ( MAXC5.5 / MINC30.5 >= 1.20) AND
3) That’s it. Make that change, resave and then repeat Steps 5-8 from the scan installation instructions.
4) Pullback Was NOT Severe
On this criteria (how deep the pullback is below the pre-Pullback peak), the scan is now set to allow up
to a 50% pullback. In other words, the pullback cannot retrace more than 50% of the pre-pullback rally
for a stock to make it through into the scan results. However, you may want to tighten (permit only
smaller pullbacks) or loosen (allow larger percentage pullbacks). To do this, all we need to do is to
modify the third line of the scan code. That line currently reads:
( MINC5 >= MAXC20.5 - ( (MAXH20.5 - MINL30.5) * 0.5 ) ) AND
However, as an example, let’s say we only want to allow pullbacks of 40% or less. To make this change
we simply modify that line to read:
( MINC5 >= MAXC20.5 - ( (MAXH20.5 - MINL30.5) * 0.4 ) ) AND
That’s it. Make that change, resave and then repeat Steps 5-8 from the scan installation instructions.
Conclusion:
Before I conclude, I want to thank you for buying this guide and supporting my work. It is greatly appreciated.
I sincerely hope you found this book informative, useful (and not a dry, boring read) and you are able to use this
information to leverage all kind of pullback setups for future trading success.
That said, we’ve now reached the end of the guide. In the first section we covered what a pullback is, how to
recognize the tradable ones and what makes them tick. In the second section we broke down two approaches to
trading pullbacks and walked through how to analyze the setup and create a trading plan for each approach.
Then in the last section I provided copy and paste scanning code that you can use to start finding and trading
pullbacks right away. I even provided instructions on modifying a few of the variables in case you would like
to experiment with variations of the version provided.
This should be everything you’ll need to find, recognize, understand and trade Pullbacks of all types. However,
if you do have any questions, please feel free to contact me at any time. I will get back to you just as soon as I
can. My email address is:
ed@candlestickbreakout.com
Thank you again and I wish you the best of luck in the market.
Ed Carter
PS
On the next page you will find a blank template for the trade plans used in this guide. Hopefully that will be
useful as you analyze various potential trades.
Trade Plan Template
Trade Plan:
Ticker/Contract:
Date:
.
Pattern:
Setup Trigger:
Buy Box:
Initial Stop:
First Target:
Action at 1st Target:
$
% of Buy Box
1st Risk Profile:
Risk =
% ($ buy / $ stop)
Reward =
% ($ buy / $ target)
Minimum Reward / Risk Ratio =
to 1
Risk =
% ($ buy / $ stop)
Reward =
% ($ buy / $ target)
Maximum Reward / Risk Ratio =
to 1
Second Target:
Action at 2nd Target:
$
% of Buy Box
Third Target:
Action at 3rd Target:
$
% of Buy Box
Last Target:
Action at 4th Target:
$
% of Buy Box
-orRaise Stop and ride until stopped out.
Trade Expectations: