Trading Breakouts vs Trading Pullbacks

5.3

3 ratings

2,485 views

Article
Beginner
2

Jasper Lawler

12 May, 2017

in Technical Analysis

Trading breakouts or pullbacks, which is better? This is a hotly contested debate, even among professional traders – but it shouldn’t be!

 As a quick reminder:
- Buying a breakout is buying when the price is moving up and above an area of resistance.
- Buying a pullback is buying when the price is moving down towards support, typically sometime after a breakout higher
- Vice versa for selling.

There are advantages and disadvantages to both of these approaches. As traders we need to fully UNDERSTAND and ACCEPT the range of possible outcomes from our strategy. Only then can we feel comfortable executing it again and again over time.

Let’s look at an example.

Chart 1: USDJPY 1hr candlestick chart

Placeholder

In Chart 1, a trader is analysing a chart of USDJPY at the ‘You are here’ point in time. The trader has decided the trend is down and is anticipating the move lower shaded in green before it happened. Let’s go through the pullback and breakout opportunities labelled 1-4 on the chart.

  1. A first attempt to sell a pullback is unsuccessful because the price pulls back past the previous peak where a stop-loss would logically be placed.
  2. A first attempt to sell a breakout beneath the previous low is unsuccessful because it is a false breakout. The price moves back into the sideways price range instead of continuing lower.
  3. A second attempt to sell the pullback is successful because the price turns lower before the previous peak where the stop loss would logically be placed.
  4. A second attempt to sell the breakout is successful because the price continues to move lower into a downtrend.

The important thing to realise is that the small loss experienced by both methods (1 & 2) would have been easily eclipsed by the following win (3 & 4).

Of course the markets don’t always move like ‘Chart 1’. Sometimes there will be more losing trades, sometimes there will be none. The trend could also reverse so there will not be a winning breakout or pullback in line with the existing trend.

Nevertheless ‘Chart 1’ is a good example of what we can expect to happen when trading a breakout and/or a pullback. The idea is that those small losses are expected and manageable and over a series of trades the big winners will make you profitable.

So which is best? You guessed it – both.

Trading breakouts and pullbacks both work. There are thousands of traders profitably doing both every day! The point is that they don’t work all the time but if losses are kept small, a patient trader can wait for the big winner.

You need to be logged in to post comments or rate this article.

Nice illustration of simple trading. Surely, nobody can interpret the chart in any other way at each point, and from that the course of action is clear. I like that Jasper's stops are at rational levels based on prior TA, while there is no mention of profit targets.

May 16, 2017

Member (6250 posts)

Re: Trading Breakouts vs Trading Pullbacks

I always theoretically avoid the first two breakouts , the area of breakouts are often violent zones of supports and resistances, I just wait for price action ,inter market correlations and "extreme " weakness or strength of hourly candles.Look for high probability trades backed by fundamentals.

May 16, 2017

Member (3626 posts)

Loading...