Breakout & Pullback
Steve Sollheiser
www.UniversalTradingProfits.com
Our trading decisions will be based on actions that price can perform in relation
to trendlines. There are three scenarios that price can perform:
Bounce
Breakout
Pullback
I will now explain each scenario and demonstrate in charts.
Bounces
Bounce occurs when price touches a Support or Resistance level and bounces in
the opposite direction. These are strong signals that we will incorporate in our
trading repeatedly.
Examples for bounces were shown in the last pages:
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Price bounced several times on these support and resistance levels. The more
bounces – the stronger these levels are. We will only trade on levels that have at
least 2 bounces. Levels with 1 bounce only are not strong enough to serve as
trading signals.
Breakouts
Breakouts occur when price breaks a support or resistance level. They are usually
accompanied with high volume and big movement of price. We will not trade
these signals.
Examples for breakouts:
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Fig. 1: Breakout of a dynamic Resistance level
Fig. 2: Breakout of horizontal Support level
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Fig. 3: Breakout of Resistance trendline
Fig. 4: Powerful breakout of Resistance trendline
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Breakout signals attract many inexperienced traders that mistakenly think that
the Breakout is a profitable signal.
Breakout is usually an unreliable signal whose continuation is doubtful. Price may
appear to break a certain level but will close below it – this is known as 'Fakeout'.
This happens a lot, especially when trading in small time-frames (Day Trading).
When trading stocks, you can trade breakouts, though you will suffer from the
same drawback these signals have.
This drawback is the inability of placing a stop loss at a logical location. When
entering on a breakout, we don't know where to place the stop loss, as price can
retrace, touch our stop loss order (closing our trade) and continue in the original
direction. In order to place a stop loss it must be far from price – thus decreasing
our profitability.
We will now describe the main signal we will trade, one with highest power and
reliability.
Pullbacks
Pullbacks occur when price re-touches a Support\Resistance previously broken.
This is one of the highest quality signals and we will trade them in many chart
patterns.
Examples for pullbacks:
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Fig. 5: Price broke Support trendline, then re-touched it – and continued down
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Fig. 6: Pullback after breakout of Support. Note the strength of the movement and the precise
reversal signal.
Fig. 7: Precise pullback after breakout of Resistance trendline
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Note that pullbacks should occur at few bars after the breakout. If the pullback
doesn't occur quickly we will discard it as a potential trade. This is because
psychological levels tend to lose their reliability as they became older. Always aim
to trade newest trend lines and discard the old ones.
The pullback is an extremely strong trading signal, which results in frequent
winning trades. This is empowered by the fact that when trading pullbacks, we
are actually trading with the prevailing trend! The breakout that came before the
pullback confirmed the strength of the trend – and enhances the quality of our
signal.
When Trade is Confirmed
We will now describe a very important subject – exact timing of trades. Until this
point we have discussed the scenarios which we will trade (bounces and
pullbacks). Now we will describe when exactly each scenario is confirmed – and a
trade should be entered. Do not worry if the rules are not completely understood
– numerous examples of these techniques will be given in the following chapters.
Bounce
Bounce is confirmed after:
1. Price created one candle in the opposite direction of previous candle.
2. A second candle passed the low of the previous (for short trades) or high
(for long trades).
Examples:
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Fig. 8: Long entry confirmed after the second Bullish candle closed
Fig. 9: Entry prices are marked on chart
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Fig. 10: Short entries are marked on chart
Pullback
Pullback is confirmed the same way as bounce.
At all future chart pattern examples, exact entry point will be marked.
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