The Secrets of Trading The First Pullback: A Price Action …1.droppdf.com/files/HeuaA/the-secrets-of-trading-the-first... · fails 6.1 how pullback fails? 6.2 when pullback fails

Content1PREFACE2INTRODUCTION3GLOSSARY4HOWTHEMARKETWORKS?4.1MARKETDRIVERS

4.2PRICENEVERMOVESINASTRAIGHTLINE4.3REVERSIONTOMEAN

4.4KEYPOINTS5PULLBACKS5.1WHAT’SAPULLBACK?

5.1.1SingleandMultibarPullbacks5.2THEMOREPULLBACKSYOUKNOW,THEMOREPREPAREDYOUCANBE

5.2.1SimplePullbacks5.2.2ComplexPullbacks5.3FINDINGPULLBACKS5.4MEASURINGPULLBACKS5.4.1ABriefIntroductiontoFibonacci(Fib)5.4.2FibonacciRetracements(FibRet)5.5KEYPOINTS6WHENPULLBACK

FAILS6.1HOWPULLBACKFAILS?6.2WHENPULLBACKFAILS6.3WHENFAILEDPULLBACKFAILS6.4FINALTESTOFTHEEXTREMES

6.5KEYPOINTS7HOWTOUSEAPULLBACK?7.1CLUESFORSUCCESS7.1.1Depthofapullback7.1.2TrendBars7.1.3Horizontal

Support&ResistanceLevels7.1.4KnowingtheMarketPlayersandTimeframe7.2KEYPOINTS8THEBESTPULLBACK8.1NEXTBESTENTRY8.2FIRSTPULLBACKINNEWDIRECTION

8.3COMBININGCLUESFORFIRSTPULLBACKS8.3.1ConvictionofaFailedPullback8.3.2SpottingBigPlayersatMarketExtremes

8.4OTHERFORMSOFFIRSTPULLBACKS8.4.1ReversalPatterns8.5KEYPOINTS9BUILDINGACASE9.1STACKINGPROBABILITIES9.2KEYPOINTS10MASTERY–WHAT’STHATALLABOUT?10.1FOURSTEPSTOMASTERY

10.2TECHNICALMASTERY

–THEJOURNEY10.3MINDMASTERY–

TRADINGINTHEZONE11FURTHERDEVELOPMENT

1PrefaceWhenIstartedtradingthemarket,myfirsttradingsystemwascalledtheSniper.Thesystemreliesonpriceactionsetupsonthe5minutechartinatrendingmarket.Theprimaryindicatoristhe50ExponentialMovingAverage(eMA)butyourelyonastrongcorrelationamongstmultipletimeframes.Inshort,ifdonecorrectly,

thisisascalpingtechniquewhichcangenerateprofitablereturnsusinglowriskentries.Thesystem,tilltoday,isoneofthebestsystemsthatIlearned.Apartfromtheintensity,thelearningcurvewassteepandrewarding–especiallyintheareaoftimeframecorrelations,priceactionandchartindicators.Moreimportantly,whileit

wasthefirstsystemthatItraded(onaliveaccount),itwasalsothefirstsystemthatintroducedmetotradingmarketPullbacks.Ofcourse,thatwasthefirstofmanysystemsthatItraded.OthersystemsthatIpickeduplaterprovidedinsightsintodifferentmarketconditions–includinganyreversalandrangingmarkets.Afterawhile,likemanyamateur

traders,Irealisedthatasystemisjustasetofrulesgoverningyourentriesandexits.Throughexperience,Ifoundoutthat,beyondanytradingsystems,therewasamysteriousmarkettheorycalledPriceAction.(Yes,thatincludedthemarketPullbackthatwaspartofthemarkettheory).Mycuriositypushedmetolearnmoreand,alongthe

way,Istartedtoremovechartindicatorsandbegantoputmyattentiononpriceandpricepatternsonly.Atonepointinmytradingcareer,Iwasonlytradingusingnakedchartsandpricepatterns.Sincethen,readingpriceactionbecamethecoreofmytradingandithelpedmematureasatrader.Oneday,duringmytradereview,Iaccidentallyfounda

commonthemeamongstallthetradesthatI’vemade,IrealisedthatIhavebeenusingpullbacksinallmytradingsystems.ThemoreIexploredthat,themoreIrealisedtheyexistinallmarketsandanymarketconditions.Somepullbackswerebiggerthanothers,andsomehadahigherprobabilityofsuccess.Ontopofthat,IfoundoutthatMarketPullbackscanpotentially

providelowriskbuthighprofitableentries.Withthat,Ihopetosharemytheoryinthisbook.Hopefully,youcanenjoyitsoonerorlater.

2Introduction“Sometimesthebestthingsarejustrightinfrontof

you.”Believeitornot,youseepricepullbacksalmosteverytimeyouopenyourpricechartbecauseitisinevitablethatpriceiscyclingandpullingbackandforthallthetime.However,manytradersdonotseeit.Thatjustgoestoshowthathumans(including

traders)canbesoengrossedintheirownthingthattheyoftenfailtoseetheobviousthatisrightinfrontofthem.Whilethisbookisprimarilyaboutpullbacks,thisisalsomywayofbreakingdowninformationfromwhatseemstobebulkyblocksintolittleabsorbablechunksandbuildingthembackintousefulresources.Bybreakingtheprocessdown,youare

abletospotthevariouscluesinthemarketeasily.Themorecluesyoufind,themorelikelythatyouhaveasuccessfultrade.Atthesametime,neverforgetthebiggerpicturewhentrading.Sincethebiggunsaretheonewiththedeepestpocket,itmakessensetokeeptrackofwhothosemarketleadersare.Bykeepingtrack,Idon’tmean

searchingforthetraders’information.Instead,Iamreferringtounderstandingwhatandhowpriceisreactingtocertainchallengesinthemarket.Infact,themoreyouunderstandpriceaction,theeasieryoucanspottheleader.Tradingpriceactionpullbackscanbeveryprofitableifdonecorrectly.Hence,Ihopetoshowyoua

varietyofpullbackpatternsandhopefullyyoucanusethatasastartingpointtofinetuneyourowntrading.Learningtotradeisajourney.However,onceyoubuiltasolidfoundation,therestofthejourneyshouldbeeasier.Also,itisprofitabletradingpullbackifitiscongruentwithyourtradingbeliefs.Hence,Ihopetoexplainhow,whyandwhentrading

pullbacksworks.Moreimportantly,youshouldalsounderstandhow,whyandwhentheydonotwork.

3GlossaryGlossaryinalphabeticalorder

-Bear-Aninvestor’stermreferringtotheseller.OppositeofBulls

-BigPlayers-ReferringtolargesizemarketplayersincludingCentralbanksormajorfinancialinstitutions.SeealsoMidPlayersandSmall

Players.-Bull

-Aninvestor’stermreferringtothebuyer.OppositeofBears

-Ceiling-Atermtorepresentahorizontalupperresistanceline.Alsoknownashorizontalresistanceline.Foraceilingtobevalid,thetouchesoftwoormorepricehighsare

required.-Channels

-Apricechannelisacontinuationpricepatternthatslopesupwardordownward.PriceisboundedbytheUpperResistanceLineandLowerSupportLine,creatingasloping(price)rectangle.

-ConsolidatedMarket-Aperiodofconsolidationthatis

drivenbythelackofvolume,indecisionoruncertainty.Irrespectiveofthereasons,themarketlacksaclearleaderinthemarket.Alsoknownasarangingmarket.

-DTD-DominantTrendDirection.-Thisisthemaindirectioninwhichthe

marketismoving.-Fib

-Fibonacci-FibRet

-FibonacciRetracement

-Floor-Atermtorepresentahorizontallowersupportlines.Alsoknownashorizontalsupportline.Forafloortobevalid,thetouchesoftwoormoreprice

lowsarerequired.-H&S

-Head&Shoulder.Thisisthenameofaspecificreversalpattern.

-Leg-Alegisthejourneytravelledbypriceinasinglemovement.Forthepurposeofthisbook,weassumethatasimplepullbackhas3legs.

-LiquidMarket-Amarketwherethereareplentyofbuyersandsellers.Withsuchvolumeoftraders,thespreadbetweenthebidandaskpricestightens.Tradeexecutionbecomeseasierandquickerasthereisalwaysanavailablebuyer/seller.Theoppositeofaliquid

marketisathinorilliquidmarket.

-Long-Totakeapositioninthemarketwiththeviewthatpriceoftheassetwouldgohigher.OppositeofShort

-LowerSupportLine-Alinethatisdrawnusingatleasttwopricelowstoformthelowersupportline.OppositeofUpperResistance

Line-Market

-GenerallyreferringtotheFinancialMarket.

-MidPlayers-Referringtomid-sizebigmarketplayersincludingMid-sizedorsmall-sizedbanks,largehedgefunds,marketmakers,largecorporateorcommercialcompanies.

SeealsoBigPlayersandSmallPlayers.

-Nakedcharts-Cleanchartsusingpricebarsonlywithoutanysignalsorindicators.

-PinBar-Thiscanbeahightestoralowtestbar.

-PriceAction(PA)-Themovementofpricewithinthefinancialmarket.PA

alsoincludestheareasoftechnicalanalysisandchartpatterns.Somemayevenincludecandlestickanalysis.

-PriceCyclicity-Thenatureofthemarketpriceswhereismovesupanddown–evenwhenthereisacleartrend.

-Pullbacks-Happenswhen

pricemovesonebar(ormore)againstitspreviousbarthatismovinginthedirectionofmajortrend.

-Short-Totakeapositioninthemarketwiththeviewthatpriceoftheassetwouldgolower.OppositeofLong

-SmallPlayers-Referringtosmallsizemarketplayers

includingRetailorprivateindividualtraders.SeealsoBigPlayersandMidPlayers.

-UpperResistanceLine-Alinethatisdrawnusingatleasttwopricehighstoformtheupperresistanceline.OppositeofLowerSupportLine

4HowtheMarketWorks?

TheFinancialMarketisacommonplacewhereinvestors,buyersandsellersexchangetheirgoods.Buyerslookforsellersofferingthelowestpriceandsellerslookforbuyerswhoarebiddingforthehighestprice.Intermsofmarketbehaviourandpriceaction,thereisn'tahuge

differencebetweenthefinancialmarketand,say,thepropertymarketorthefoodmarket.Ofcourse,thenatureofthevariousfinancialmarketsisdependingontheproductsboughtorsold.ThisistrueandisapplicableformarketsliketheCurrencymarket,Commoditiesmarket,Stock&Equitiesmarket,Futuresmarket,Optionsmarket,

Bondmarketsandmore.Eachmarketisgovernedbyitsownrulesandregulation-Somearecentralisedandsomearedecentralised.Duetothesedifferences,somemarketshavemorepeoplethanothers,andthatmakesonemarketmoreliquidthantheother.Withtheboomoftheinternetandtechnology,buyersandsellersdonotevenneedto

meetupanymore.Thetruthisthat,apartfromprice,buyersandsellersarenottoobotheredaboutwithwhomtheyareexchangingtheirgoods.Aslongasthepriceisright,that'sallthatmatters.However,hereisanimportantpieceofadvicethatIlearnedafewyearsago,asamarkettrader,itiswisetomakeyourselfextremelyfamiliarwithonemarket

beforeventuringintomore.Sinceeachmarkethasitsownpersonality,ittakestimeandextremefocustounderstanditbeforeyoucanmasterit.Onceyoudomasterit,you'llbemakingenoughmoneythatyouwon'tbebotheredtolearnmore.

4.1MarketDriversThefinancialmarketmovesfordifferentreasonsand,moreoftenthannot,there'snoorlittlepointinfindingoutthosereasons.Ofcourse,I'llbelyingifIsaidthatthemacroeconomy(aswellasmarketsentiment)hasnoimpactonthemarket,becausetheydo.However,asashorttomediumtermtrendtrader,thesefundamental

reasonsonlygivemeamacroviewoftheoveralltrendbutitdoesnotgivemetradingopportunities.Butbeforeexplaininganddescribingwhatdrivesthemarket,thefollowingare4(outofmany)examplesthatareusefultogettheballrolling.GutFeeling

JohnisanoiltraderworkinginGoldman

Sachs.Heusuallyarrivesatworkbeforesixinthemorningbutwasrunningslightlylateoneday.Johnusuallybrowsesthroughhisemailonhiswaytoworkbut,ashearrivesinhisLondonofficethatmorning,hegotanewemailreportfromtheirresearchteamtitled"BullishOutlookonOilPrice".

Havingsomesizablepositionsoncrude,Johnstartstogothroughthereportandbeginstorationalisehisthoughts.Whilethereporthasbeenfairlyreliableinthepast,Johnwasnotcomfortablewiththereport.Hecouldnotpinpointwhatwaswrongwithit,buthedecidedtokeeptohisownbearishviewinstead.Alreadyinprofit,he

decidestoclosehisentirepositionbeforehegoesonabreakwithhisfamily.WhileJohnwashavingbreakfastonhisseconddayintheFrenchAlps,hesawanewsheadlinegoing"ViolenceinIraqdespiteUSpullout".AsIraqhasthesecondlargestprovenoilreservesintheworld,anyunfavourablemajoreventscaneasilydisrupt

theoilproductionandhencethepricesofit.Johncarriedonhisbreakfastwithasmile.

EmotionsKevinisaproprietarytraderinamajorWallStreetfirminNewYorkcity,andhehasbeenafairlysuccessfulone.HismanagerdecidedtopushhimalittlefurtherandagreedtoletKevin

manageamuchlargerportfolio.Kevinwasextremelyexcitedaboutit.Whilethemoneywasnotsignificanttothebank,itwasalargesuminKevin'seyes.Oneday(Day1),Kevintookalongpositionintheinterestratefutures.Forevery0.01move,hegains$27k.Thispositionsizewasallnewtohimashe

hadneverdealtwithsuchalargepositionbefore.OnDay2,therewasanunexpectedannouncementbytheECBPresidenthintingapotentialinterestraterise.Asthenewsannouncementwenton,themarketwhenmaniconthatinformation.However,becausethenewsdidnotmakesense,Kevindecidestohanginthere.

Day4,thevolatilitycontinues.Atonestage,Kevin'spositionwasatalossof$500kandallthathappenedwithin2hoursbeforeitrecoveredslightly.Kevinstartedtoquestionhisowndecision.Atthatpoint,theoptionsincluded,(1)closingthepositionwithoutriskingfurtherlossor(2)toincreasehispositiontorecoverfromhisloss.

Kevin'sselfconfidencewasataminimallevel,andtherewasmuchuncertaintyintermsofhowheshouldhavedealtwiththetradesinceDay2.Day5,whenKevinwalkedintotheoffice,deprivedfromsleep,Kevinwasemotionallydrainedanddecidedthatitdidnotlookrightanymoreandmadethedecisionto

cutlosses.Day6,themarketfinallyresumedtonormal.UnfortunatelyforKevin,theratesrecoveredandmovedinhisfavour.

TechnicalPaulisatraderinahedgefund.Whileheoverlookstheoperations–specificallythesmoothentryandexitsoftrades–ofthefund'stradingdesk,

heisalsoatechnicalanalysisexpert.BecausePauldoesnotmanagehisownbooks(orportfolio),heonlytakestradeswhenTim,thefundmanager,sendshimthetradeinstructions.Asandwhenhereceivesthoseinstructions,Paulhasaspecifiedtimeandpricerangewherehemusttakethosetrades.

Oneday,thefundmanagerwantedhimtotakesomepositionsinGoogleInc.Assoonashegottheinstructions,PaulstartstoanalysethetechnicalsettingsofNASDAQ:GOOG.AsPaulhadfivedaystoenterthetrade,hestartedlookingattheweeklychartbeforehemoveddowntothedailyand4hourcharts.Basedonhis

analysis,heknewtherewerenotradesonDay1.Infact,nothinghappeneduntilDay4whenPaulfinallygotthesignalthathewanted–aMACDcrossover–showingthepotentiallowoftheweekandthestartofatrendcontinuationsetup.Assoonasthepricehitapredefinedsupportlevel,Paulboughtthoseshares.

FundamentalsTomworksinRolls-RoyceintheTreasuryteamwithinGroupFinance.Asthecompanyhasaninternationalpresence,halfitstransactionsaredealtinforeigncurrencies–predominantlyinUSDollar(USD).Meanwhile,becauseRolls-RoycewasaBritishcompany,mostoftheiroverheadcostsare

primarilydealtinpoundsterling(GBP).AstheUSDcontinuestodropagainsttheGBP,Rolls-Royce'sprofitmargincontinuestobediluted.Theonlyotherwaytoprotectthecompanyfromcurrencyexchangerateriskwastohedgethecurrencypositions.Asthetraderwithin

treasury,Tomreviewsthemacroeconomicindicatorsaswellascompany'scurrencypositiononamonthtomonthbasisbeforehepresupposeshowmuchhedgingisrequired.Ofcourse,thiswouldalsoinvolvesomemathematicalcalculationonexpectedsalesfiguresaswellasexpectedexpenditurefortheforeseeablefuture.While

thismayseemlikeachallengeforsomecompanies,RollsRoyce'sbusinessmodelisprettylongterm,andthisisquiteamundanetaskforTom.UponapprovaloftheFinanceDirector,hetypicallytakesacurrencyfuturepositiononbehalfofRollsRoyce.

WhileJohn,Kevin,PaulandTommightnotbereal

people,therolestheyplayedseemhighlyplausible.Theultimategoaloftradersistoincreasewealthandmostprofessionaltradersenterthemarketforreasonsthatareuniquetothemselves.However,themarketisdrivenbymillionsofindividualswhorepresenteitherthemselvesorsomeoneelse(includingbigfinancialinstitutions)–justlikeJohn,Kevin,PaulandTom.

Mypointisthis,nooneknowswhythemarketmovesthewaytheydobecauseevensomeoftheprofessionaltraderscannotexplainthemselves(GutFeelingtraders).Hence,ifyou,aretailtrader,thinkthatyouknowwhythemarketisdoingwhatitisdoing,thenyousoundlikeyou'reinadangerousposition.Also,whilemacroeconomic

factorsplayanimportantroleinthefinancialmarket,theyprobablyplayalessimportantroleinanestablishedtrendandwhenlookingatshorttomediumtermmarkets.Moreimportantly,manyofthemacroandfundamentalinformationhavebeenincorporatedintopriceaction.Believeitornot,fundamentalinvestorsareinthemarkettoo.However,thefinancial

marketisinefficientbynatureandpricewouldoftenreflectthatinformationeitherbeforeorafterthedata/newsrelease.

4.2PriceNeverMovesinaStraightLine

Nowthatyouunderstandthedriversofthemarket(whichisfairlyunpredictable),youshouldalsoappreciatethatthemarketpricesnevermoveinastraightline(forthesamereasons).Foryourinformation,thisisthehonesttruthaboutthemarket.Infact,theoppositeistrue–marketpricesalwaysmove

upanddownevenwhenthereisacleartrend.Thisphenomenonisknownaspricecycle.Likeitornot,thisistrueforallmarketsandallmarketconditions–includingthetrending,reversingorsidewaymarket.Thefollowingaresomeexamplestoillustratemypoint.TrendingMarket

Diagram4-1:DownwardTrendingMarket

Theaboveisabearmarketandsellerswereclearlythedominantplayershere.Althoughthesellersaretakingcontrol,itshouldbeclearthatthebuyersandsellersconstantlycompetetotakeadvantageofthemarket–nooneevergivesinthateasilywithoutagoodbattle.Asyoucansee,eachtimepricemoveslower,buyers

comeintothemarketaspricebecomescheaper.Ontheflipside,whenpricemoveshigher,sellersstarttoclosetheirpositionsastheytakeprofit.Ofcourse,sincetherearemoresellersthanbuyers,thesellersalmostalwaystakecontrolofthemarketandcontinuetopushthepricelower.Theresultofthatwasazig-zaggingmarketthatisonits

waydownastheoverallpricemoveslowerandlowergradually.ReversingMarket

Diagram4-2:ReversingMarket–FromanUpMarketintoaDown

Market

Herethebuyersweretakingcontrolofthemarketfromthestartandcontinuouslypushthepricehigher.Likethetrendingmarket,sellerswerealsolookingforopportunitiestoselleventhoughbuyerswereincontrol.Halfwaythroughthechart,buyersrealisedthatthey'vedonetheirbest,andtheycan't

seemtosupportthepushanymorebecausepriceisnowdeemed"tooexpensive".Ifthebuyershaveemptiedtheirpocketsandareincapabletosupportingtheuptrend,thensellerswouldbemorethanhappytoenterthemarketata"good"price.Hence,thesellersstartedsellingthemarketandthebuyersstartedclosingtheirpositionsatthesametime.

Again,asthesellersgraduallytakecontrol,somebuyersfeelthattheremightbechancesofrecoveryandtheywerehopingtoremainincontrol.Thus,theytrytobuildsomesmallbullishpositionsalongthedownwardmarket.Inlaymanterm,thesebuyersarecalled"laggers"–incaseyoumightbelaughingindisbelieve,trustme,laggersexistsinanymarketplace.

Aspricecontinuestofall,someoftheearlierbuyersmightdecidetotakeprofitandswitchovertobecomeasellertotakeadvantageofboththemarkets.Ontheotherhand,somebuyerswhopanicbecausepricesarefallingsharplymightclosetheirpositionsveryquickly,andthiswouldfuelthefall.Asyoucansee,theactivitiesinthemarketplaceare

endlessand,thus,therearealwaysreasonstocausepricestomoveupanddownconstantly.ConsolidatingorRagingMarket

Diagram4-3:SidewayRangingMarket

Evenifpriceweretomove

sideways,itmovesbycyclinginanarrowpricerange.Inthisexample,buyersandsellersareinequilibrium.However,don'texpectpricetomoveinastraightlineeveniftheyareinequilibrium.Instead,weonlyknowthatthereisn'tmuchtradablevolumeinthemarketsinceeachtimepricereachesafloor(i.e.bottomofthepricerange),buyerswouldseethatasanopportunityto

buy.Analternativeviewisthattherewerenotenoughsellerstopushpriceanylower.Theoppositeisalsotrue,andthathappenswhenpricereachesaceiling(i.e.topofthepricerange).Sellersseethatasanopportunityaswellandwouldjumpintothemarkettosellbecausepriceisnowhighenough.Astherewereinsufficientbuyers,

pricenaturallymoveslowerwhensellerscomein.Asthemarketlacksvolume,thefloorandceilingcanoftenfluctuatealittlesincethereisnosingleplayerthatistakingcontrol.Nonetheless,likeanyothermarket,nothingiseverpermanent.Itiscommontofindtradersorinvestorswhowouldtakeadvantageoftheselimitationsandleverageittomakesome

shorttermprofits.Thus,differenttypesofbuyersandsellerswillpushthepricesasayo-yo.MixedMarket

Diagram4-4:DowJonesIndexshowingMixedMarket

Diagram4-5:IdentifyingMarketswithinMarkets

Nowthatyou'veseenthedifferenttypesofmarketconditions,itmightbeworthhavingalookatamixedmarket.TheDowJonesIndex(dailychart)inDiagram4-4isanotherexampleofhowthemarketnevermovesinastraightline.Ontopofthat,pricemovesfromonemarket(condition)toanother.Ifit'snotobvioustoyou,then

havealookatDiagram4-5whereyoucanseetherearetrending(arrows),reversing(R)andranging(rectanglebox)marketsinthereandallofthemactinginrandomsequences.Whilepriceiscyclingwithinthethreemarkets,theaboveisalsoagoodexampleofhowpriceiscyclingactivelyeveninthebiggerpicture(ormacromarket).

TimeframesandLiquidityPricecyclesinalltimeframes.Inotherwords,youcanfindpricecyclingwithintheTrending,ReversingandRangingmarketsandthatcanhappeninthedaily,4hourly,60minutes,15minutes,5minutesandeventhe1minutetimeframe.However,forpricetodothat,themarketneedstobeliquid.Agoodindicationofaliquid

marketiswhenyoufinditrelativelyeasytoexecuteyourtradeandyoucandosoatorclosetoyourdesiredprice.Thisispossiblebecause,wheninaliquidmarketasthecurrencymarketorevensomeFortune500companies,youcanfindbuyersandsellersofallsizesexchangingfinancialassetsallthetime.Justtobeclear,price

continuestocycleeveninanilliquidmarket.However,itiseasiertofindpricecyclesinsmallertimeframeswhenthemarketisliquid.

4.3ReversiontoMeanNotonlydoesthemarketmoveincycles,itactuallymovesinacertainpatternandthatpatternisdrivenbytheconceptofMeanReversion.Thatmeans,themarketalmostalwaysreturntothemeanoraveragepriceafteritmovesawayfromit.Forsimplicity,itmightbeeasierifyouthinkofitasapendulum.Imaginea

pendulumswingingfromlefttorightandback,thecentreofthependulumislikeameanposition,andthependulumwouldalwaysgetpulledbacktothecentrebutthenitalsogetspushedawayfromthecentre.

Diagram4-6:ReversiontoMean–DistancefromMean(x)VsTime(t)

Graph

Thediagramaboveshowsthedistance(x)ofthependulumawayfromthemeanposition(zero)againsttime(t).Asyoucansee,pricealwaysmovesawayfromthemeanbeforeitreachesanextreme.Pricethenrevertstothemeanfromtheextremeasifthereisamagneticfieldpullingitbacktothecentre.Priceactionworksinthesamewaywhentravellingin

cycles.Whilethemeanofapendulumisconstantlyzero,themeanofthemarketpriceisconstantlymoving.Infact,inatrendingmarket,pricedoesn'tevenreturntothemeanbeforeitmovesbackintothetrenddirection.Anotherinterestingfactthatyoumustbeawareisthatitisdifficulttopredicthowfarpricemovesawaybeforeitispulledtowardsthemean

again.Manyhavetriedtopicktheextremes(i.e.markettopsandbottoms),and,unfortunately,that'snotawisedecision.Infact,with-trendtraderswouldwaitforpriceactioncluesafterpricetoppedorbottomedbeforebuyingorsellinginthenewtrenddirection.

Diagram4-7:GoogleIncshowingReversiontoMean

Asshownabove,theGoogleInc(daily)chartshowsthatpricehasbeencyclingupanddownconstantly.Aspartofpricecycle,itisalsoconstantlybeingpulledbacktowardsthemeanprice(movingaverageline)beforemovingawayfromitagain.

Diagram4-8:RangeMarketVsTrendingMarket

Let'smakethisslightlymoreinteresting,ifyousplitthechartin2,youcanfindarangingmarketandatrendingmarketinthere.Intherangingmarket,priceiscrossingfromonesideofthemeanpricetotheotherandthatissomewhatsimilartothependulum.Ontheotherhand,inatrendingmarket,priceusually

staysononesideofthemeanpriceonly-thisisagoodindicationofastrongtrend.Nonetheless,pricecontinuestocycleanditisstillbeingdrawnbacktothemeanpriceonceinawhilebeforemovinghigheragain.

4.4KeyPointsHerearethesummariesandkeypointersforthissection:

-Marketsaredrivenbymultiplereasonsthataredifficulttoquantifyandthat’sincludinghumanemotions,fundamentals,technicalanalysisoranyotherunknownreasons.-Pricenevermovesinastraightline.Infact,itisconstantlycyclingupand

down.-Whilepricecyclesarerandomastheyswitchbetweentrending,reversingandconsolidatinginanunpredictablesequence.Nonetheless,youcanstillfindsomepredictablepatternswithinthoserandommovements.-Marketextremesarewherethose"magneticfields"arestrongest,and

youcanexpectapulltowardsthemean(oraverage)pricefromthoseextremes–alsoknownasReversiontotheMean.However,nevertrytopicktopsorbottoms.

5Pullbacks5.1What’saPullback?

MarketorpriceactionPullback,bydefinition,happenswhenpricemovesatleastonebaragainstthedominanttrenddirection(DTD).Apullbackisapricemovementthatmovesintheoppositedirectionofthetrendbutitisonlytemporarilypricemovementbeforeit

resumesbackintothemainmarketdirection.PullbacksaresometimesreferredtoaspriceRetracementsorCorrections.SomemayevenjustcallitaDip.Itdoesn’tmatterwhatyoucallitaslongasthetemporarycountertrendmovementresumesinthemainmarketdirectionlateranditdoessobybreakingbeyondtherecentprice

extreme.Ifpricedoesnotgobeyondtherecentextreme,thenthepullbackcouldreverse,oritcouldconsolidate.

Diagram5-1:ABCDPattern

Forthepurposeofillustration,wewillusebeusingtheABCDpatterntoexplainthedetailsofsimplepullbacksbecausetheABCDpatternisaperfectexampleofit.Ontopofthat,asimplepullbackalwaysmovesinthreelegs.Usingthediagramabove,inanuptrend,ABisthefirstlegwherepriceismovingtowardstheDTD.

Thisisfollowedbythesecondleg(BC)andthecycleiscompletedassoonasthefinalleg(CD)movesbeyondB.Justtobeclear,theactivityapullbackisonlyrepresentedbyBC.However,forthesakeofcompleteness,apullback(BC)mustremainbetweenAandBanditmustincludeCDwhereDmovesbeyondB.Ifnot,thatwouldbe

consideredafailedpullback–furtherdiscussiononfailedpullbackcanbefoundinSection6.1.Note:Alegisthejourneytravelledbypriceinasinglemovement.Forthepurposeofthisbook,wecanassumethatasimplepullbackhas3legs.Youmayfindthatothertradersreferthemdifferently.

5.1.1SingleandMultibarPullbacks

Diagram5-2:ExampleofSingleBarPullback

Thediagramaboveshowsasinglebarpullbackexample.Itshowshowapullbackcanbeshortandquick.SincethedefinitionstatesthatpriceneedstomoveatleastonebaragainsttheDTD.Inthisexample,thetrendbar(priortothesinglesellerbarinthecircle)representsABandthesellerbarisBC.Thenexttrendbarthatmovedabove

theentiresellerbarisCD.Hence,thisisavalidpullbackeventhoughtheABCDpatternisnotobvious.Inthisexample,theentireABCDpullbackcanalsobeconsideredasasinglelegsincethe3legsarereallysmall.

Diagram5-3:ExampleofMultiBarPullback

Thenextdiagram(above)isamultibarpullback,anditshowsafewsellerbarsbeforepriceresumedbackintotheDTD.Apullbackcanbeshallowordeep,anditcanbefastorslow.Whilethedepthandspeedofthepullbackareindependentofeachother,theyareofteninfluencedbythemarketdriversatthatpointintime,andnoone

reallyknowswhenanyofthemhappens.Again,wewilldiveintothecharacteristicsofpullbacksinalatersection.Fornow,justappreciatethatpullbackscanhappeninvariousshapes,depthsandspeeds.Also,doappreciatethefactthatpullbacksarenaturaloccurrencesinthefinancialmarket,andthesearetradingopportunitiesfortraders.

However,unlessatraderunderstandshowpullbackswork,apullbackisnothingmorethananotherpricepattern.

5.2TheMorePullbacksYouKnow,TheMorePreparedYouCanBe

Incaseyouhavenotrealised,inorderforpricetocycle,theremustbeapullback.Thinkaboutit,priceneedstopullbackbeforeitcanpushforward.Andtherepetitionofpullingbackandpushingforwardiswhatcontributestoapricecycle.

AsmentionedinSection4.2,wherethemarketisliquid,pricewillcycleinallmarketconditions,inanytimeframeandanydirection.Ifthatistrue,thenthismustalsomeanthatpriceswillmakepullbacksinanymarketconditions,anytimeframeandanydirectionaswell.Astraders,insteadoftryingtopredictthefuture,itismoreusefultorecognise

thesepullbacksandthenperformyouranalysisbasedonhowthesepullbacksbehave.Rememberthattradingisaboutstackinguptheprobabilitiesinourfavour,andthisisexactlywhatyouaretryingtoachievehere.Byrecognisingthevarioustypesofpullbacks,youcanpicktradesthathaveahigherprobabilityofsuccessinorder.Oncewehavetheprobabilitiesinour

favour,wetakethetrade.Forthepurposeofillustration,Ihavegroupedmarketpullbacksintwodistinctgroups–simpleandcomplexpullbacks.

5.2.1SimplePullbacks

AsimplepullbackshouldbeintheshapeofanABCDpattern.Hence,theyareusuallyfairlyobviousandeasytospotwhilecomplex

pullbacksmighttakealittlelongertoform.However,asimplepullbackcanremainsimple,oritcanevolvetobecomeacomplexpullbackaswell.Sincewedon’tknowwhenthathappens,itisimportanttomanageyourriskandmoneywisely.Ifyoufindyourselfspendingtoomuchtimelookingforsimplepullbacks,it’s

probablybecausetheyareeithercomplexones,ortheyarenotapullbackatall.Eitherway,whenthathappens,youshouldjustignoreitandlookfortradingopportunitieselsewhere.Thefollowingaremoreexamplesofsimplepullbacks.DeepPullback

Diagram5-4:DeepPullback

Let’sstartbyhavingalookatadeeppullback.Thisisprobablyamongsttheeasierpricepatterntospot.Characteristicsofadeeppullbackare:

-Inadeeppullback,thepricemovesasignificantdistanceagainsttheDTD,andthisisthekeyidentifierofadeeppullback.

-Itcanbehappenquickly,oritcanhappenslowly.Inotherwords,itcanalsobeasharppullbackevenifitisadeepone.-Itisusuallymadeupofafewconsecutiveseller(orbuyer)barswithoneortwobarsthatarerelativelylongerthantherest.However,thekeyisthedistancetravelled(asopposedtothetypeof

bar).-Readingpriceactioninthediagramabove,inadeeppullback,thebearsareusuallytryingtoshowtheirdominants.However,notrealisingthatthebullsarestillstrong,thebullsusuallycomebackintothemarketjustbeforethebearsmanagedtobuildconfidence.

ShallowPullback

Diagram5-5:ShallowPullback

Characteristicsofashallowpullback:

-ThepullbackmovesverylittleagainsttheDTD.Thisisthekeyidentifierofashallowpullback.-Itcanbehappenquickly,oritcanhappenslowly.Itcanalsobeaflatpullbackifturnsouttobesidewaymovement.

-Itusuallycomprisesamixtureofdojiandsmallbodiedbars.Sometimes,youcanalsoexpecttoseelongtailedbars.Thetypeofbarsyougetislessimportantasit’sthemovementofthebarsthatmatters.-Ashallowpullbackisusuallyanindicationthatthemarketisone-sided.Readingthepriceactioninthediagramabove,the

bearsonlymanagedtopushpriceslightlyintherefavour,andthebullswerealreadybackinthemarket.Hence,priceisexpectedtomoverelativelyfarafterthepullback.

SharpPullback

Diagram5-6:SharpPullback

Characteristicsofasharppullback:

-Thisisusuallyaveryquickpullbackandthespeedofthepullbackisthekeyidentifier.-Althoughasharppullbackistypicallymadeupofonlyoneortwobars,itcanalsohappenwhenyouhavemultiplebars,butthereisaclearcounter

trendmovementwithinarelativelyshortspanoftime.-Thesharppullbackcanbeconsideredadeeppullback.Havingsaidthat,youcanoccasionallyfindsharppullbackthatisrelativeshallow.Eitherway,theideaistokeepaclosewatchandnottopredictthemarket.-Thepriceactionaboveshowedsomeselling

strengthinitially.Withsuchastrongbeartrendbar,thesellerswerehopingtoattractmoresellersintothemarketbutonlyrealisedthatthebuyerswerestillincontrolandthatpushdidnotgofar.

FlatPullback

Diagram5-7:FlatPullback

Characteristicsofaflatpullback:

-Aflatpullbackisconsideredashallowpullback.However,itisslightlymoreextremethanyourtypicalshallowpullbackbecausethemarketonlymovessideways,withverylittlecountertrendmovement,beforeitresumesinthe

DTD.-Thesidewaysmovementiskeyidentifierforthispullback.-Aflatpullbackisanindicationofaverystrongmarket.-BasedonthepriceactionabovebuyersoftenfailtofindagoodlongentryintotheDTDbecausepricebarelyretraces.Manywaitedforaminorreversaltoshow

confirmationthatpriceiscorrectingitself–unfortunately,duetothebigplayersdrivingthemarket,pricecontinuesitsbullrunbeforetradersevenrealiseit.5.2.2ComplexPullbacks

Thepurposeofthissectionistogiveyouthetoolstonavigateinthemarketand,moreimportantly,tostayout

ofitwheninacomplexpullback.Inotherwords,whenyouseeacomplexpullback,Iwouldstronglysuggestthatyoushouldstayoutofthemarket.Complexpullbackshappenwhenpricestepsintoaconsolidatingphase.ItthenremainsconsolidatedforawhilebeforeitresumesintotheDTD.Noonereallyknowshowlongitremainsconsolidatedbeforeitmoves

again.Ontopofthat,ifyoustruggletorecognisethepricepatternsonyourcharts,Ibelieveitisonlyreasonabletosaythatyoushouldstayawayfromitandfindanotherclearerchartwheretheprobabilityofmakingaprofitishigher.Tradingisabouttaketradeswhereyoufeelright,thesetupshouldberecognisablewithinsecondsandnothing

more.Note:Beforewestartlookingatexamplesofcomplexpullbacks,itiscrucialtorememberthatsimplepullbacksarepricepatternsthataremuchmoreprofitabletradesbecauseyoueitherseethemoryoudon’t.Don’tbefooledbytheideathatyoushouldmakemoneyineverymarket.Infact,many

professionaltradersonlytradeonsimplepullbacksbecausethat’salltheyneed.Rising/FallingWedgePullback

Diagram5-8:RisingWedge

Diagram5-9:FallingWedge

Characteristicsofarising/fallingwedge:

-Arisingwedgeoccurswhenyouhaveapriceactionpullbackthatisslopingupwardswheninadownwardtrendingmarket(asshowninDiagram5-8).Meanwhile,thepricerangeofthepullbackbecomesnarrowerasitgoesagainsttheDTD.

-Whenpricemakesapullback,youcaneventuallyspotanupperresistancelineonthetopandalowersupportlineatthebottom,sittingbetweenprices–asshowninbothdiagramsabove.Boththelinesconvergeaspriceactionbecomesnarrower.-Asthewedgestartstonarrow,thatisanindicationthatthemarket

isbecomingmoreindecisive.Asinvestorsseethis,theywouldalsobegintositoutofthemarket.Inotherwords,thisbecomesaself-fulfillingprophecyasthewedgecontinuestonarrowevenmore.-Likeaspringbeingcompressed,pricegetssqueezedtothepointwhereithasnochoicebuttoburstoutwith

momentum.-Inarisingwedge,thepullbackendswhenpricebreaksbelowthelowersupportlineandviceversaforafallingwedge.-Alltheaboveappliestoafallingwedgebutintheoppositedirection.

Note:SeetheGlossarypagefordefinitionofUpper

ResistanceLineandLowerSupportLine.Rising/FallingFlagPullback

Diagram5-10:RisingFlag

Diagram5-11:FallingFlag

Characteristicsofarising/fallingflag:

-Arising/fallingflagisverysimilartoarising/fallingwedgewiththeexceptionthatthepricerangestaysconsistentaspricemovesagainsttheDTD.Inotherwords,theupperresistancelineandlowersupportlineareparalleltoeachotheras

pricepullbacks.Thus,creatingasmallpricechannel.-Justliketherising/fallingwedge,thepullbackendsassoonaspricebreaksoutofthechanneltowardstheDTD.-However,sincepricedoesnotconverge,itdoesnotbreakoutlikeaspringeither.Thus,itcanbechallengingwhenidentifyingwhereprice

turns.-Occasionally,pricewouldcontinueinthenewdirection(againsttheDTD)regardlessand,hence,makingitareversalpatterninsteadofapullback.

Sideway/RectanglesPullback

Diagram5-12:Sideway/Rectangle

Characteristicsofasideway/rectanglepullback:

-Asideway/rectanglepullbackisasidewaypricemovement,anditcanbedefinedusingarectangleboxwherethetopandbottomlimitoftheboxisdrawnusingthehorizontalupperresistanceline(forthetop)andhorizontalbottomsupportline(for

thebottom).-Rememberthatitisimportanttohaveatleasttwopricetouchesonboththetopandbottomrespectivelytodefinetheboundaryoftherectangle.Withoutthatconfirmation,thepullbackcouldevenendupasawedgeoraflagpullbackinstead.-Toacertainextend,asidewaypullbackisessentiallyaflatpullback

butcomprisesofmorepriceactionandmovements.

DoubleBottom/TopPullback

Diagram5-13:DoubleBottomPullback

Characteristicsofadoublebottom/toppullback:

-AdoublebottompullbackoccurswhenpriceretracestothesamepriceleveltwicebeforeitresumesbackintotheDTD.Inanuptrend,thishappenswhenpriceretracestotouchthehorizontalbottomsupportlinetwicebeforeresuming

toitsmaintrenddirection.-Whiledoublebottomisatypicalreversalpattern,itisnotuncommonintrendcontinuationpullbacks.Infact,sometimes,rectanglepullbacksaredeemedadoublebottompullbackaswell.-Lookingatthediagramabove,thesellersattemptedtosellthemarketbutthebuyerstook

control,formingashallowpullback(leftcircle).Afterthat,thesellersmadetheirsecondattempttopushthepricelower.Whiletheylookedsuccessfulinitially,thebuyerssteppedinagainatthepricenearthefirstattempt.Thistimeround,thebuyerswereserious,and,fromthenon,theytookchargeofthemarket.-Alltheaboveapplies

toadoubletoppullbackaswellbutintheoppositedirection.

Ascending/DescendingTrianglesPullback

Diagram5-14:AscendingTriangle

Diagram5-15:DescendingTriangle

Characteristicsofanascending/descendingtrianglepullback:

-InDiagram5-14,anascendingtrianglepullbackwasformedwhentherewasarelativelystronghorizontalupperresistancelinethatwasholdingpricefromgoinghigher.Eachtimepricehitstheline,itdrops.

However,eachtimeitdrops,thefallweakens.Thus,itstartsmakinghigherlowsand,likeawedge,pricestartedtoconverge.-Fromamarketpsychologypointofview,thisseemstosuggestthattherewasalargesellorderplacedatafixprice(wherehorizontaluppersupportlineislocated).Eachtimethebuyerspush

pricetothatlevel,pricedropsaspartoftheordergottriggered.Thiscontinuesforawhileuntiltheentireorderwasclearedandoncethereweren’tanymoresellers,pricepushedhigher.-Theoppositeistrueforadescendingtriangle.-Ascending/descendingtrianglesareoneofthemoreattractivepatternstotrade.Since

priceonlymovestowardsthedominanttrenddirection,theextremesarenotretested.However,theproblem(likeallothercomplexpullbacks)isthatyoudon’tknowwhattoexpectuntilithappens.-Sometimes,youmayfindpricebreakingoutofthetrianglewhereitgoesagainsttheDTDtoo.Thus,thisbecomesareversalpatterninsteadof

apullback.PennantsPullback

Diagram5-16:PennantPullback

Characteristicsofapennantpullback:

-Pennantissimilartoasymmetricaltriangle.Ithasaslopingupperresistanceline,aslopinglowersupportlineandboththeselinesconvergetoformatriangle(asshownabove).-Justlikethewedge,buyersandsellersare

consolidating,andtheconsolidationcausespricetofunneltowardsanequilibriumpoint.Typically,pricewouldstartmovingagainbeforeitreachestheextremetipofthetriangle.-Pennantsarenicetolookatinhindsight.However,itischallengingtopinpointwhenpricewouldresumebackintotheDTDagain.

-Liketheothertriangles,itisnotsurprisingifthisturnsouttobeareversalpattern.

WideningWedgePullback

Diagram5-17:WideningWedge

Characteristicsofawideningwedgepullback:

-Awideningwedgehappenswhentheupperresistancelineandthelowersupportlinediverge.Whilepricelookslikeit’spotentiallyformingasimplepullback,pricewouldstarttoswingvigorouslyonbothends.-Thebuyersandsellers

aredefinitelyinawar.Unlikepreviousconvergingpullbacks,wherebuyersandsellerssatasidetowaitforfurtherconfirmation,thisisatug-of-warinthemaking.Buyerswouldpushpricehigherbutstrongersellerswouldtakeoverassoonasitreachesahigherprice.Thebuyerscameinagainassoonaspricemoveslowerandthebuyers

pushedpriceevenhigherinthenextround.Theprocessrepeatsitselfuntilaclearwinneremerged.-Asyoucanimagine,awideningwedgeisoneofthemorecomplexpullbacksanditiswheremostnewtradersoftengettrapped.

5.3FindingPullbacksNowthatyouunderstandtheideaofmarketpullbacksandyouhavearoughideaofwhattheylooklike,let’smoveanotherstepforwardandtrytofigureouthowyoucanfindthepullbacks.Rememberthatpricenevergoesinastraightline?I’msureyoudo.Withthat,pullbacksareeasiertospotifyouthinkofpriceactionas

pricethatiscyclingupanddown.Anotherimportantkeyconceptthatyouneedtoknowaboutpriceisthat,forpricetocyclehigher,youneedaswinglowbeforeitmovestocreateaswinghigh(andviceversa).

Diagram5-18:RepeatedABCD

Lookingatthediagramabove,youcanseehowtheABCDpatterniscyclingup

anddownrepeatedlyinanuptrend.StartingfrompointAandBontheleft,watchhoweachpriceactionpullbackcreatesaswinglow(C)whichisfollowedbyaswinghigh(D).Inordertospotanewpullback,changetheCandDtoaNewAandNewB.Ascyclerepeatsitself,anotherpullbackdevelopstocreateanewswinglow(NewB)and

anewswinghigh(NewD).Asyoucanimagine,thiscarriesonforawhileaslongaspricecontinuestocycleintheDTD.

Diagram5-19:DefiningSwingHighsandLows

InsteadofcountingtheA,B,CandDs,acommonwayof

lookingforpullbacksistousetheannotationofswinghighs(H)andswinglows(L).Hence,itisusefulifyouthinkofpricepullbacksastheycyclewithalternatinghighsandlows.

Diagram5-20:HighsandLowsinDownwardTrendingMarket

Diagram5-21:HighsandLowsinReversalMarket

Diagram5-22:HighsandLowsinRangeMarket

Asshowninthethreediagramsabove,theshortlinesrepresentthehighs(H)andlows(L)ofeachpricecycle.Inadowntrend,aH-L-H-Lwouldrepresentonecycle,andHiswherethepullbackislocated.Meanwhile,inanuptrend,aL-H-L-Hwouldrepresentanothercycle,andLiswherethepullbackislocated.Evidently,thereisapullback

ineachpricecycleandpricecycleshappeninanymarketconditions.Hence,ifyoustruggletofindpriceactionpullbacks,allyouneedtodoisdrawthehighsandlowsonyourchartsandyoucanalmostseethemimmediately.Incaseyouhaven’tnoticed,pullbacksandswingsarelinkedandtheyareprettymuchinterchangeable.Readingpriceactionusing

swinghighsandlowsisagreatwayforspottingpullbacksandpullbacksaregoodwith-trendmarketentries.ThisisalsoagoodalternativetoABCDpatterns.BothSwingHandLareequallygoodwhencomparedtoABCDpatterns.Moreimportantly,neitherisbetterthananotherasbothareequallygood.Infact,thebestonesaretheonesthatwhatworksforyou.Somakesure

totrybothandfindoutforyourself.

5.4MeasuringPullbacks

TheFibonacciRetracement(FibRet)isapowerfultooltousewhenidentifyingkeyareaswherepullbacksendbeforemovingbackintotheDTD.However,sincepriceactionisdrivenbymarketplayers,theyarenotexactscienceandtheyhavetheirlimitationstoo.Hence,donotworshipthetoolbutuseitin

moderation.Moreimportantly,useitalongothertoolsthatyoumayalreadyhave.

5.4.1ABriefIntroductiontoFibonacci(Fib)

FibonaccinumberswereintroducedbyLeonardoPisanoBogollo(1170-1250),anItalianmathematicianfromPisa.Heisknowntohavediscoveredthenumbers,

whichareasequenceofnumberswhereeachsuccessivenumberisthesumofthetwopreviousnumbers.Example:1,1,2,3,5,8,13,21,34,55,89,144,233,377,610……Asshown,whenyousumanumber(n)toitsprecedingnumber(n-1),you’llgetthenextinsequence(n+1).Forexample,whenyouadd1+1,youget2?Whenyou

add5+8,youget13?Orwhenyouadd233+377,youget610?Andsoon.Thesequenceextendstoinfinityandcontainsmanyuniquemathematicalproperties.ThesenumbersarebasedonLiberAbaci–abookonarithmeticbyLeonardoofPisa,knownlaterbyhisnicknameFibonacci.LiberAbaciwasamongthefirstWesternbookstodescribe

Hindu–Arabicnumberstraditionallydescribedas"ArabicNumerals"Themainratiousedis0.618–thisisfoundbydividingoneFibonaccinumberintothenextinsequenceFibonaccinumber(Example:Both55/89or377/610=0.618).Meanwhile,theinverseofthatiscommonlyknownastheGoldenRatio–1.618.Otherratiosinclude

0.236,0.382and0.764.ItisunderstoodthatFibonaccinumbersanditsratiosrepresentmanynaturalphenomena.Ofcourse,thathappenstoincludethefinancialmarket–sincepricesaredrivenbyhumanbeings(ashumanstooarepartnaturalphenomena).

5.4.2FibonacciRetracements(FibRet)

AstheseFibonacci(Fib)

numberscanbeappliedintechnicalanalysis,Fibratioshavebeenusedbymanytraderstoidentifyareaswherepricewouldpotentiallyreverse(attheendoftheretracementsorpullbacks)backintotheDTD.Withoutanysurprises,thetypicalFibratiosthatareusedinclude23.6%,38.2%,50%,61.8%,76.4%and100%.However,38.2%,50%and

61.8%areknownasthekeyratiosandhavebeenfoundtobemoreusefulthantherest.Hence,manytechnicaltradersalsoassociatethisasaFibRetratio.The50%FibRetisnotaFibonaccinumber.Nonetheless,thisnumberisderivedfromDowTheory’sassumptionthatpricegenerallyretracestohalfitsprimarypricemovement.

FibRetratiosaremoreusefulwhenpriceisinatrendingmarketbecauseitisassumedthatpriceislikelytocontinueinitsmajortrenddirection.Withthat,let’shavealookatsomeexamples.38.2%FibPullback

Diagram5-23:38.2%FibPullback

Asshownabove,whenyoudrawtheFibRetratios,the38.2%ratioshowedthatitwasagoodareaforpricetoreversebackintotheDTD.Since38.2%wasrelativelyshallow(comparedto50%or61.8%),itcanbeassumedtobeashallowpullback.Hence,itcarriesthecharacteristicsofashallowpullbackwhichwasdiscussedearlier.

50%FibPullback

Diagram5-24:50%FibPullback

Thenextexampleisthe50%FibRet.Thislevelisthemidpoint(betweenAandB)anditisquitecommonforpricestobounceintheareabetweenthe50%and61.8%levels.Thesharppullbackaboveshowsthatpricehadrespectedthe50%ratiobeforeitstartedheadingnorthagain.61.8%FibPullback

Diagram5-25:61.8%FibPullback

61.8%Fibisapullbackthathaspassedthemidpoint.Whiletheterminologyislessimportant,asaFibonacciuser,weneedtorememberthe50%-61.8%isafavouredretracementareainthefinancialmarket(asmentionedpreviously).Lookingatthediagramabove,pricecamedownandtestedthe50%Fibbeforeit

movedfurtherdowntotestthe61.8%Fiblevel.Asyoucanimagine,itisnotuncommonforpricetotesteachratiobeforesettlingforone.

5.5KeyPointsHerearethesummariesandkeypointersforthissection:

-APullback,bydefinition,happenswhenpricemovesatleastonebaragainstthedominanttrenddirection(DTD).Itisonlytemporarilycounter-trendpricemovementbeforeitresumesbackintothemainmarketdirection.

-Themoretypesofpullbackyoulearn,themoreyouarereadyandpreparedforthemarket.-Simplepullbacksareeasytospot,andtheyareprofitablesetups.-Complexpullbacksaremoredifficulttospotbutkeeppracticing,andyou’llbeabletoseethemcominginadvance.-FibonacciRetracementratioisa

goodtooltohelpidentifyareasofapotentialreversalofpricebackintotheDTD.38.2%,50%and61.8%areknownaskeyFibRetratios.-IfyoustruggletofindpullbacksusingABCDpatterns,agoodalternativetospottingpullbacksisbyspottingswinghighs(H)andswinglows(L).

6WhenPullbackFails“Knowthyself,knowthy

enemy.Athousandbattles,athousandvictories.”

–SunTzuAsSunTzusaysit,knowingyourselfisonlypartofthegames,ifyouknowyourenemytoo,youcanwinmanybattles.Ifyouwanttosucceedin

usingpriceactionpullbacksinyourtrading,youneedtoknowhowpullbacksfailtoobecause,whenithappens,youarepreparedforit.Onceyoulearntonavigatethemarket,throughsuccessfulandfailedpullbacks,youarecertaintoprogressprettyfarinthiscareer.Withthat,thissectionistoexplorepriceactionleadingtoapullbackfailureandwhat

ouroptionsarewhenithappens.

6.1HowPullbackFails?

Diagram6-1:SimplePullback

Usingtheexampleofasimpleuptrendpullback,wedefineapullbackwhenpricemovesagainstthedominanttrenddirection(DTD)momentarily(fromBtoC)beforeitreversesbackintotheDTD(fromCtoD).

Diagram6-2:WhenPullbacksareCompletedVsWhenPullbackFails

Asmentionedearlier,theterminologyofapullback

onlyrepresentsBC.However,forthesakeofcompleteness,apullbackmustincludeCDwhereDclearlymovesbeyondB.Ontheotherhand,ifCclearlymovesbelowA,BCisnolongerapullbackandthatisthepointwherethepullbackfails.Justareminder,itisimportantthatabreakbelowpointAshowsconviction,becauseaconvictedfailure

representsamarketleadertakingcharge.Toillustratemypoint,let’slookatanexample.

Diagram6-3:FailedPullbackonUSDCHF(DailyChart)

TheSwissy(USDCHF)currencypairdailychartaboveshowsafailedpullback.Startingfromtheleftofthechart,themovedowntoC(afterABmadeanewhigh)lookedlikeanormalpullback.Infact,thesmall-bodieddoji(barC)seemslikeareasonableindicationtoshowthatthesellershavehadenough,andthebullishtrendbarafterthatwasagoodsignalshowing

thatthebuyerswereback.However,CDdidnotgobeyondB.Instead,priceturnedatDtomovesouth.ThepullbackbecameinvalidatedassoonaspricemovedbelowA,andbarEwaswhereithappened.Whenthathappens,Ebecomesthefirstlowerlow(LL)intheuptrend.

6.2WhenPullbackFails

Diagram6-4:WhenPullbacksFail

WhenCmovesbelowA,thatmeansthepullbackhasfailed.Thisisanimportantpricepatternfortrendtraderstorememberbecause,whenapullbackfails,thechancesarehighthatthemarkettrendhasended.However,thisdoesnotimplythatthemarketisgoingtostarttrendingintheoppositedirectionimmediately.Manynewtradersassumethatwhen

thetrendingmarketends,you’llgetareversalmarketimmediately.Unfortunately,that’snotthecase.Whenatrendends,thereisa50:50chancethatpricewouldreverseintothenewdirectionoritcouldstartmovingsideways.Infact,ifyougetasidewaysmarket,youcouldstillfindthemarkettrendingagainintheolddirectionattheendofthesideway

market,andthatisnotsurprisingatall.

Diagram6-5:DowJonesIndexshowingMixedMarket

TheDowJonesIndexabove(takenfromDiagram4-5)showedhowpricemovedfromonemarkettoanotherinnoparticularorder.Thisjustgoestoshowthatthemarketdoesn’tnecessarilyreversesimmediatelyafteratrendingmarketendseventhoughitcould.Tosumitup,herearethepotentialoutcomeswhena

pullbackfails:-Marketmovessideways

-Afterthat,itcontinuesintheoriginaltrenddirection,or-Afterthat,itreversesandstartsanewtrendintheoppositedirection

-Itreversesandstartsanewtrendintheopposite

directionAsyoucansee,themarketworksinitsmysteriousways.However,whilethemarketisrandom,wecanstillnarrowdowntheoptionsandbepreparedwheneitherofthemhappens.

6.3WhenFailedPullbackFails

Diagram6-6:DefiningtheFailureofaFailedPullback

Let’spushthisonenotchhigher.Nowthatyou’reawareoftheimportanceofpointAandBinanABCDsimplepullbackpattern,let’sexplorethesetwopointsslightlymore.Asmentionedearlier,afailedpullbackisagoodindicationofchangeoftrend.However,itisnotsurprisingthatyoucancomeacrossafailed

pullbackthatfails.Essentially,inanuptrend,thishappenswhenpricemovesbelowpointAbutfailstosustainthedrop.Inotherwords,youhaveafalsebreakbelowPointA.ThisisnotsurprisingaswellsincePointAisalsoahorizontalsupportlevel.Asyoucansee,thatiswhyitisimportanttogetaclearbreakbelowPointAbefore

youcanbecertainthatthemarketconditionhaschanged.IfthereisnoconvictiontobreakbelowPointA,whichwasagoodindicationthattherewereinsufficientsellerstopushthepricelower,buyersseethatasanopportunitytobuythemarketatanevencheaperprice.Thekeyatthisstageistostartlookingforcluesinthe

marketagain.Oneoftheapproacheshereistofigureoutwhichmarketplayerisbuying–isitabigplayeroramidplayer?Ifyoufindastrongbullishpinbarfollowedbybullishtrendbars,thechancesarehighthatthebigbuyersareback.Ifnot,thenbepreparedforevenmoreuncertainty.Forsmarttraders,therealconfirmationthatthebullsare

backiswhenyougetaclearbreakabovepointB.Thisisalsoimportantbecause,withoutthatconfirmation,pricecanevenmakeasecondattempttotestPointA.Whenthathappens,thereisapossibilitythatneitherthebuyersnorsellersaredominantanymore.Infact,pricecouldhaveshiftedintoarangingmarketbeforeyourealised.

Diagram6-7:Gold(1hourchart)showingaFailureofaFailed

Pullback

TheGold(1Hour)chartaboveshowedafailureofa

failedpullback(circle).PricemadeasmallspikebelowPointAbutmanagedtoclosewithapinbarwherethebodyofthebarwascompletelyabovePointA.Allthesepriceactionarecluestoshowtheprobabilityofconvictedbreakwasfairlylow.Inthisexample,pricedidnotshowmuchconvictionafterthefailureofthefailedpullbackandpricestartedto

wondersideways.Barswithlongtailsandsmallbodiesareclassicexampleswheretherewaslittleconvictionfromeithersideofthemarket.Inotherwords,thefailureofafailedpullbackwasthestartofevenmoreuncertainty.

Diagram6-8:SP500Index(4Hour

chart)ShowsalongContinuationafteraFailureofFailedPullback

TheS&P500Indexshowedanotherfailedpullbackthatfailedona4hourchart(bar1).Lookingatpriceaction,thiswassomewhatsimilartoadoublebottompullback(barAand1)wherethehorizontalsupportlevelwastestedagainbutitfailedtobreakbelowit.Afterthefailure,pricestartedmovinghigher,andtherewereevidencethatbigger

buyerswerepresentassoonasyousawlongbodiedandshorttailedtrendbars(bar2).ThefinalconfirmationwaswhenpricebrokeabovePointB(bar3and4).

6.4FinalTestoftheExtremes

Beforeweexplorethefinaltestoftheextremes,let’sheadbacktothebasicideaofreversiontomeanthatwasdiscussedinSection4.3.MarketExtremesOneofthebeautifulphenomenaaboutthetradingthemarketisthatthemarketisdrivenbyhumans(orhumanbehaviour)and

humansareusuallyresistanttochanges–thisisespeciallytrueatmarketextremes.That’sthesamereasonwhythebuyersandsellersoftenputupagoodfightbeforeacceptingthatthemarketconditionshavechanged.

Diagram6-9:ExtremePositions

(Box)ofaPendulumSwing

Inordertounderstandtheconceptofmarketextremes,let’suselookatthependulumagain.Tobeginwith,weknowthatthependulumswingsfromonesideofthemeantoanother.Atacertainpointintime,ithastomoveawayfromthemeanbeforeitreachesanextremeposition(theboxesinthediagram

above).Thenitreversesandswingstowardsthemeanagain.Ifyoubelievethattheextremepositioniswherethependulumreverses,thenyoushouldalsobelievethatthesamehappensinthefinancialmarketbutithappensatmarketextremes.Unfortunately,thefinancialmarketisnotasstraightforwardasthependulum

becausenooneknowswherethemarketextremeis.Hence,theonlywaytofindoutistoconstantlytestthemarketuntilwereachedtheFinalTest.FinalTestEventhoughbuyersandsellersareconstantlytestingthemarket,therewillalwaysbeadominantpriceleaderwhenthemarketistrending.However,thetestofthe

market(betweenthebuyersandsellers)becomesmoreintensewhentheyapproachmarketextremesbecauseitisattheseextremesthatthepriceleaderchangesfromthebuyerstosellersorviceversa.Hence,thetermFinalTestrepresentsthefinalattemptbythebullsorbearstopushpricesfurtherbeforeitreverses.

Withthat,herearesomeexamplescenarioswhenpriceisnearmarketextremes.

Diagram6-10:TestoftheExtremes

Ifyoucan,couldyouimagineamarketthatisatanextremeofapricecycle?Lookingatthediagramabove,imaginethemarketyouarelookingatissimilartoit?Priceisshowinghigherhighs(HH)andhigherlows(HL),whichisahealthyindicationofabullishmarket.Eachtimethemarketmoveshigher,thereisatestofthelasthighbecause,foranew

HHtoexist,itneedstobreakandgobeyondthelastHH.Thesetestsbecomemorechallengingasthemarketgetsexhausted,andthenumberofbuyersandsellersmovesclosertoequilibrium.Asyoucansee,themarketmadearecentHLanditbeginstocrawlhigheragain.With-trendtraderswouldlookforthebreakofthelastHHagainasaconfirmation

ofapullback.However,ifthemarketshowssignsofexhaustion,traderswouldbelookingforthosesignsshowingweaknessandwouldstayoutofthemarketuntilthereisconfirmationorevencluesofreversal.Essentially,anyofthefollowingcouldhappen.LowerHigh&LowerLow

Diagram6-11:LowerHighandLowerLow

WorkingfromDiagram6-10,sincethestartofthelastHL,

pricemadeaLowerHigh(LH)asthisiswherepricefailedtobreakabovethelastHH.ThisisfollowedbyaLowerLow(LL)whichisaconfirmationthattheLHisthefinaltest.Justtobeclear,theLHdoesnotconfirmthefinaltestbecauseyoucanstillgetadoublebottompullbackandpricecouldcontinuenorth.However,assoonaspricemadeaLL,thatwastheconfirmationthatthepullback

hasfailed.BoththeLHandLLaregreatcluesshowingthestartofadownwardtrend.Also,thisisaclassicfailedpullbackpattern.DoubleTop

Diagram6-12:DoubleTopandLowerLow

Alternatively,pricecouldhavemadeaclearfinaltest

whenattemptingtomakeanewhigh.However,onthisoccasionitdidn’tasitfailedtobreakabovethelastHH.Infact,thefailuremadeadoubletopinstead.Similartothepreviousscenario,aLLisrequiredforconfirmationofthefinaltest.WithouttheLL,pricecouldturnouttobeaflatpullback,anditcouldendupmovingsidewaysinsteadbeforemakinganothertestoflasthigh.

Adoubletopisaslightlyearliercluethatthebullsarelosingcontrolandthatthesellersaregettingreadytoenterthemarket.Becausethedoubletopisobvioustoyou,itmeansthatothertraderscanspotittoo.Hence,thelikelihoodthatotherswouldgetintothetradehasincreasedtoo–thusbecomingaself-fulfillingprophecy.

HigherHigh&LowerLow

Diagram6-13:HigherHighandLowerLow

Thediagramaboveshows

anothercommontestoftheextreme.PricemadethefinaltestwhereitfinishedwithanewHH.Nonetheless,thesellerscameintothemarketandcompletelytookcontrolofprice.Whilethisusuallytrapsthebulls,itisalsoastrongpriceactionpatternshowingcommitmentfromthesellerswhodominatedthemarket.Smartbuyerswhoseethiswouldlikelystayoutofthemarket.

DuetothedistancetravelledfromHHtoLL,pricewouldalsolikelyhaveformedabearishtrendbarwhichisanothergoodcluethatthesellersareback.Essentially,theaboveissomewhatsimilartoanengulfingbarcandlestickpatternifitwasshowninacandlestickchart.HigherHigh&HigherLow

Diagram6-14:HigherHighandHigherLow

Lastly,itwouldnotbesurprisingatallifprice

climbedhighertomakeanotherHHbutthiswasfollowedbyaHL.Thisonlymeansthattherearemoreteststocome,andthisisnotthefinaltestyet.Essentially,thisisbacktosquareoneandanyoftheabovepatternscouldpotentiallyhappeneitheronthenexttestoranytimeinthefuture.

6.5KeyPointsHerearethesummariesandkeypointersforthissection:

-Itisnotsurprisingthatpullbackscanfail.Infact,itisimportantthatyouknowhowandwhentheyfailsothatyouarepreparedforit.-Thefailureofafailedpullbackisequallyimportantwhentradingpullbacks.Onceyou

understandthat,nothingcansurpriseyouanymore.-Understandingthefinaltestoftheextremesistounderstandthatbuyersorsellersrarelygiveupeasily.Theexamplesshowingthetestsoftheextremeshowsthevariousscenariosofhowmarkettrendsendandhowtheycancontinuefurther.

7HowtoUseaPullback?

Knowingwhatyouknownowaboutpullbacks,youshouldrecognisethatapullbackisaPriceActionsignal.Sincemosttechnicalindicatorsarederivedfromprice,bydefault,priceistheonlyleadingindicatorintechnicalanalysis.Aboveandbeyondthat,itissaidthat

priceactionrepresentsmarketandinvestors’behaviour.Hence,somewouldgototheextenttoarguethatpriceactionincorporatesfundamentalanalysisandmacroinformation.Inotherwords,pullbacksarepowerfulindicators.Withthat,let’sidentifyhowthiscanbedone.

7.1CluesforSuccessIfyouwanttofullyutilisepullbacksinyourtrading,itisworthunderstandingwhenandhowapullbackcanbeprofitableand,inordertoachievethat,thereareafewkeyareasthatweneedtoestablishbeforeevenconsideringtakinganytrades.OneofthekeyareasthatI’mreferringtoismarketcluesthatarepotentiallysignsof

strengthinpriceaction.Yousee,ourobjectiveastradersistonotpredictthefuture.Youmayask–“Ifwearenotpredictingthefuture,thenhowelsearewegoingtomakemoneyfromtrading?”Withthat,Iwouldliketoinviteyoutothinkoftradingintermsofanexerciseofstackingprobabilities.Insteadoftryingtopredictthefuture,wesearchforcluesinorder

tostacktheprobabilityofsuccessinourfavour.Hence,themoreclueswecanfind,themorelikelythatthepullbackcanworkinourfavour.Thissectionisaboutunderstandingthevariouscluesforsuccessinthemarket.Ihopethatbyunderstandingtheseclues,youareabletostoppredictingandtostart

collectingcluesinstead.7.1.1Depthofapullback

Thedepthofapullbackisoneoftheeasiestandstraightforwardmethodsofidentifyingthestrengthofapullback.ShallowVsDeepPullbacksInSection5.2.1,we’veoutlinedsomeofthecharacteristicsofshallowpullbacksandoneofthe

characteristicsisthatitislikelytobeaone-sidedmarket.Thatjustmeans,inanupmarket,buyersaredominatingthebattleand,inadownmarket,sellersarethedominantones.Sincethemarketisone-sidedinashallowpullback,onlyafewinvestorspushthepriceagainsttheDTD.Thechancesarehighthatthetrendwouldremainstrongforawhile.

Hence,assoonasthepullbackiscompleted,themarketwillbewaitingeagerlytocontinueitspushfurther.

Diagram7-1:ShallowPullbackShowsStrength

Lookingatthediagramabove,thebuyerstriedtopushthepricehigher(bar1nearthearrow).However,theydidn’thavetheresourcestodoso.Ontheotherhand,sellersdidnotwaitlongbeforetheysoldthemarketagainandthatformedashallowpullback.Theshallowpullbackwasagoodsignthatthesellers

wereincontrolandtheycontinuedtopushpriceevenlower.Whilewedon’thaveexternaldatawithushere,priceactionwasshowedstrongsellertrendbars(bar2)andthesewereconfirmationsthatthesellershadthecontroloverthemarket.Also,oncethemarketstartedmovingagain,smartbuyerswhosawsuchmomentumwillstayoutofthemarket.

Hence,itisselffulfillingthatwithlittleornobuyers,themarketcanonlymoveinonedirectionandwoulddosoeasily.

Diagram7-2:DeepPullbackShowsWeakness

Theoppositeisalsotrue.A

deeppullbackoftenleadstolessaggressivepricemovementsattheendofthepullback.Theaboveexampleshowsaverydeeppullback(bar2)andpricehadgonequiteclosetothestartofthepreviouslow(bar1)beforeitresumeditsmoveintheDTD.However,asyoucansee,pricedidnotmovefarbeforeitshowedsignsofweaknessanditstarteditsmovedownagain.Asyou

cansee,thebullsdidnotshowconvictionanymoreandthereislittlestrengthinpushingthepricehigher(bar3wasthenexthigh).AsmentionedinSection6.4,asyougetclosetothemarketextremes,thisiswhenbuyersandsellersmovetowardsequilibrium.Incaseyouhaven’trealised,deeppullbacksalsoprovidesimilarclues.Hence,deeppullbacks

cansometimesbeagoodindicationthatthemarketisnearlyexhausted,andthetrendcouldendsoon.AMechanicalApproachAmoremechanicalapproachtomeasuringpullbackcanbedonebyusingtheFibRettool.AsshowninSection5.4,itiscommontofindapullbackarrivingataspecificFibRetratiobeforeprice

resumesbackintotheDTD.Theratiosthataregoodindicatorsofashallowpullbackare23.6%and38.2%.Ontheotherhand,61.8%and76.4%areconsideredhavingdeepordeeperpullbacks.Inotherwords,ifyoufindapullbackreversingaround23.6%or38.2%Fibratio,thesearepullbacksthatcouldpotentiallyindicatethatprice

cangomuchfurther.Ifyoufindpullbacksreversingaround61.8%and76.4%ratios,thechancesarehigherthattheycanshowweakness.

Diagram7-3:S&P500IndexshowingStrongSellingPressure

ThehourlychartoftheS&P500Indexshowedapullbackretracingupto38.2%Fibratio(circled)beforepricecontinueditstrenddownwards.Asshownabove,therewasagapwhenthemarketopenedbutthatdidnotaffecthowpricereactedtothe38.2%levelwhereitturnedaroundandresumeditsoriginalmove.

Aftertheinitialpullback,pricecontinuestodropandyoucouldfindmorepullbacksalongtheway.Asatrader,donotpanicasitisnormalforpricetocontinuetoretracetimeandagain.Infact,thesepullbacksgodeeperanddeeperasmoreandmorebuyersgraduallyenterthemarketcausingthedownwardmomentumtoloseitsstrength.

Diagram7-4:AUDUSDPairshowingStrongBuyingPressure

TheAUDUSDcurrencypairshowedashallowretracementonthe15minutechart(circled).Theflatpullbackaroundthe23.6%Fibratiocontinuedtopushhigher.Again,pricestartedtomakedeeperpullbacksandthesharppullback(bar1)isagoodexampleofthat.Knowingthatthereisstrengthinthemarket,smart

buyersseethesharppullbackasagoodbuyingopportunitytobuyatacheaperpricebeforepriceclimbshigher.

Diagram7-5:DowJonesIndexshowingStrongSellingPressure

Thenextdiagram,DowJonesIndexonthe15minutechart,depictsaretracementthathasapullbackratiothatislessthan23.6%.Whileitmightbedifficulttospotthesepullbacksinalivemarket,itjustgoestoshowthatthesetypesofpullbackaregreatindicatorsforstrongsellingpressure.Ofcourse,it’seasiertolook

atachartandthemarketinhindsight.However,youneedtopracticespottingshallowpullbacksbeforeyoucantakeadvantageofthem.Itisimportanttomakeanefforttosearchandtorecognisethesepullbacksastheyaregreatsetups.Theone-sidedmarketwilltiltthebiasinourfavour.

7.1.2TrendBars

Diagram7-6:BuyerandSellerTrendBars

TrendbarsorMarubozupriceactionbarshaveoftenbeenunderratedbytechnicaltradersbecausemanyseemtobelookingfortechnicalindicatorsinstead.Hence,Iwouldliketohighlightthefactthattrendbarsaregreattoshowstrengthsinthemarket,andyoushouldlookforthemespeciallyatthestartofanewtrend.Theyare

veryusefulcluesfortradingsuccessespeciallynearextremes.Essentially,trendbarsareimpulsepriceactionwhichindicatesthatthebigplayersaredrivingthemarket.Bigplayersusuallyhavedeeppocketstopushthemarket,andtheydosointhemediumtolongterm.Hence,thelongerthetrendbarsthebetter.

Ifthetrendbarislongerthantheaveragesizebar,thatisalsoagoodindicationofmomentumandthisisusuallythestartofamarketrally(ordecline).Ifyoufindthatthetrendbarshaveverysmalltailsthatisevidencethatthemarketisone-sided,andthemomentumisincreasedfurther.Alternatively,ifthetrendbarisattheendoftherun,this

canbeanindicationofexhaustion.DefinitionofTrendBarTheLongBuyerTrendbarhasshorttailsincluding:-ClosenearHigh-OpennearLowTheLongSellerTrendbarhasshorttailsincluding:-ClosenearLow-OpennearHigh

Diagram7-7:GoldShowingSellers’Conviction

IntheGold4hourchartabove,thesellersshowedconvictionassoonasthefirsttrendbarclosed(bar1).Thebarwaslongandhadshorttails.Thelengthofthebarwasmultiplesofitsprecedingbars(notshown),anditshowsthatthesellerswereserious.Aftertheinitialtrendbar,pricemadeadoubletop

pullback(circled)beforeitpresentedanothertrendbar(bar3).Smartsellerswouldhavetakenashortentryatthatdoubletoppullback.Meanwhile,thosewhowantedmoreconfirmationmayhavetakenthebreakbelowbar2assoonasthepullbackwascompleted.Alternative,moreshortpositionswouldhavebeen

takenattheshallowpullbackimmediatelyafterbar3.

Diagram7-8:FTSEIndexShowingBuyersConviction

TheFTSEIndexonthedailychart(above)startedoffwiththreebuyerbarswiththecentreonebeingatrendbar(bar1).TheJapanesecallsthethreecandlesticksaThreeAdvancingWhiteSoldiers.Whilethatwasabullishpattern,thenextbullishcluewasasimpleandsharppullback(circled)ata38.2%FibRetratiothatfinished

withalongbuyertrendbarwithsmalltails.Thecombinationoffactorsshowedplentyofreasonsthatthebullswereserious,thesubsequentrunafterthatwasjustfurtherconfirmationaspricebarelymadeanymorepullbacksuntillater.

7.1.3HorizontalSupport&ResistanceLevels

Priceactionhorizontal

supportandresistanceisasimpleyetpowerfulcluetousewhensearchingforareaswhereapullbackcouldreversebackintotheDTD.Thisisalsoconsideredmorereliablebecausethehorizontallevelsarelesssubjectivecomparedtoothercluessinceeachsupportorresistanceonlyrequireonepieceofinformation–aswinghighorswinglow.

Diagram7-9:CreatingSupportandResistanceLevels

Usingthediagramaboveasanexample,youcanseethat

eachswinghigh(H)wasidentifiedasahorizontalresistancelevel.Oncepricebrokeabovethatlevel,pricewouldthenretesttheswinghighwheretheresistancecouldturnsupport.Inotherwords,moreoftenthannot,pricesarereactingtothepriceswingscreatedinthepast.WhileeachHandLcouldbenewintheexistingcycle,someofthemcould

coincidewithpastswingHsandLs.

Diagram7-10:HammersonPLC(DailyChart)ShowingResistance

andSupportLevels

LookingattheHammersonPLC(DailyChart)above,pricemadeaswinghighatbar1andmadeahigherhighatbar2.Nonetheless,priceconsolidatedaroundbar2beforeitmadeaswinglowandanewhighafteritbrokeabovebar1andbar2.Bar3wasagoodretestofbar1swinghigh,anditturned

outtobeagoodbouncebackintotheDTD.Interestingly,pricecamebackdownagaintotestthatsamelevel(bar4)anditeventuallybecameadoublebottompullback.

7.1.4KnowingtheMarketPlayersandTimeframe

Understandingtimeframecorrelationisprobablyoneofthemostimportant

knowledgeinanytechnicaltrading.However,beforeIdiveintothesubjectoftimeframecorrelation,itmightbeworthgraspingtherelationshipbetweentimeframeandmarketplayers.MarketPlayersTherearevariousmarketplayersinthefinancialmarketandtheyeachhaveadifferentroletoplayinthe

market.Duetothevaryingobjectivesthattheycarrywiththemwhentheyenterthemarket,theyinfluencethemarketdifferently.Forsimplicity,Ihavegroupedthevariousmarketplayersinthreecategories(below).Ihavealsoincludedashortsummaryofcharacteristicsoftherespectiveplayers:

BigPlayers

-Centralbanksormajorfinancialinstitutions-Theyarelongtermmarketplayersandusuallydrivethemarketsastheyhavedeeppockets.-Theyusuallyenterthemarketforfundamentalreasonsonly.-Theyusuallyenter

themarketonalargertimeframe.

MidPlayers-Mid-sizedorsmall-sizedbanks,largehedgefunds,marketmakers,largecorporateorcommercialcompanies-Amixtureofshorttermandlongtermplayers.However,theyareusuallyableto

influencethesmallplayers.-Theyenterthemarketforfundamentalandprofitmakingobjectives.-Theyusuallyenterthemarketonanytimeframe.

SmallPlayers-Retailandprivateindividualtraders.-Theyhavelittle

influenceoverthemarket.-Theyusuallyhaveprofitmakingobjectivesonly.-Theyusuallyenterthemarketonanytimeframe.

TheBiggerPictureAsyoucansee,understandingthemarketplayerscanpotentiallyhelp

youplanaheadbecauseyoucannotignorethefactthattheyareabletoinfluenceothermarketplayers,aswellasthedirectionofmarkettrend.Inordertofurtherelaboratemypoint,herearetwoobviousrelationshipsbetweenthemarketplayersandtimeframe.Ihopetohighlighttheimportanceofthebiggerpicture.

StrongTrendingDayBarsIfyouseelongtrendbarsonadailyorweeklychart,especiallyatthestartofthenewtrend,bepreparedforastrongtrendingmarket.Asmentionedpreviously,strongtrendbarsaregoodindicationofstrengthbutatrendbaronabiggertimeframeismorereliablethanoneinan

intradaytimeframe.Asstatedearlier,thebigplayersareinthemarketforthelongerterm.Whentheyenterthemarket,theyhavetheresourcestofuelthemovementofpriceinacertaindirectionforarelativelylongtime.Abovethat,theyenterthemarketinsmallchunks–asopposetoputtingtheirentirebuyorsellordersin

onetrade.Hence,whenyouseeastrongtrendbaronthedailychart(orevenonthe8hourcharts),bereadytofollowthatsamedirectionbecausethatisusuallyagoodindicationthatthebigplayersareinthemarket.Infact,allyouneedtodoistofollowthemandtheprobabilityofwinningincreasesas

well.AimlessMarketIfyouareashorttermtrendtraderandyou’refacinganaimlessmarket,youmayfindthatyouareconstantlybeingkickedoutofyourtrade.Whileyouarecertainthatyouarefollowingyourrules,youfeelthatthemarketisagainstyou.Guesswhat?You’re

probablyright.Thesearethedaysthatyoushouldbecautiousbecause–andit’snotthattheentiremarketisagainstyoubut–thechancesarethatthemidplayers(e.g.hedgefundtraders)aremanipulatingthemarketinordertomeettheirdailyprofittargets.Thisusuallyhappenswhenthemarket(onthe

largertimeframe)isconsolidating.Rememberthataconsolidationiswhenthemarketisundecided.Thisisalsoaperiodwhenmid-playerstakecontrolastheyknowthatthebigplayersareprobablysittingout.Atthisstage,thebigplayersprobablyhavemost(orall)theirordersfilledandtheyarewaitingasideuntiltheydecidetoeitherpush

themarketfurtherortoexitit.Also,sincetheobjectiveofmidplayers(whichincludesmarketmakers)arepurelyfinancial(i.e.profitmaking),thatmeanstheycanuseofanytradingsystemsaslongasit’sprofitable.Withthat,youcanprobablyseewhytheword“manipulate”isagoodrepresentationofthe

midplayers.However,theonlyrealthingthatweknowaboutmidplayersisthattheylosetheircontrolofthemarketwhenthebigplayersarebackintothemarket.Again,theseareusuallyobviousonlargertimeframes.

Asyoucansee,theaboveareillustrationsoftwoextrememarketconditions.Thetruth

isthatthefinancialmarketusuallygoesthrougheitheroftheaboveorexperiencessomethinginbetweenatanypointintime.Thatisalsowhatdeterminesatrending,reversalandrangingmarket.Therealchallengeisthatwedon’tknowwhathappensnext.However,ifyouareuncertainaboutthemarketconditions,alwaysusealargertimeframeforclues.

Forexample,ifyouaretradinga5minutechart,itwillbeworthcheckingonthe60minutechartfordirection.Ifyouaretradinga4hourchart,itisbeworthcheckingthedailychartetc.Hopethatmakessense?Lookingfortherightmarketplayerscanbesomewhatchallengingbut,donotbedespair,becauseallyouneedispractice.Moreimportantly,

whenprobabilityworksinourfavour,priceactionusuallyshowssignofstrengthsthatcanhelpusfindthosewinningtrades.

7.2KeyPointsHerearethesummariesandkeypointersforthissection:

-Priceactionisaleadingindicatorand,hence,pricepullbackisagreatpriceactiontool.-Inordertoincreasethechancesoftradingsuccessinatrendingmarket,youshouldlookoutforcluestoincreasetheprobabilityofsuccess.

Thesecluesinclude:-ShallowPullbacks-TrendBars-PriceChannels-HorizontalSupportandResistancelevel-Knowingthemarketplayersandtimeframe

8TheBestPullback

Ifyouhavebeenfollowingthebookfromthestart,Ibelieveyoushouldhavehadadecentunderstandingofwhatapriceactionpullbackisallaboutbynow.Ifyouhave,thenlet’strytodiveintoalittlemoredetail.Sincepullbacksareeverywhere,youneedto

appreciatethefactthatsomepullbackshavehigherchancesofsuccessthantheothers.Hence,inthissection,Ihopetosharesomeideasonwaystopickpullbacksthatcouldyieldbetterprobabilitiesofsuccess.

8.1NextBestEntryIfyouwanttobeprofitabletradingmarketpullbacks,letitbenosecretthatthebestpullbackistheFirstpullback.Thefirstpullbacksarethewith-trendentriesthatcanbefoundattheverystartofanewtrend.Withthat,let’sexploretheideaoftradingthefirstpullbacks.

Diagram8-1:IdealTopandBottomEntries

Inanidealsituation,themostprofitablewaytotradethemarketistocatchtherunfromtheverytopandcashoutatthebottomofthemarket.Theoppositeisalsotrueifyoucatchitfromthebottomandexitrightatthetopofthemarket.However,thenatureoftradingissuchthatweneverreallyknowwherethetoporbottomis.

Aboveandbeyondthat,catchingthetoporthebottomofthemarketisprobablyoneofthehardertasksandmanytradershavelostsubstantialamountofmoneywhileattemptingtodoso.

Diagram8-2:NearTopandBottomEntries

Insteadofenteringthemarketatthetoporbottom,thefirstpullbackallowstraderstoenternearthetoporbottom(asshownintheboxabove),thisissomewhatsimilartoenteringatthetoporbottom,andyoucanstillenjoythemajorityofthebenefits.Hence,enteringthemarketatthefirstpullbackisthenextbestentry.

Essentially,thefirstpullbackinthenewtrenddirectionisalsothefinaltestoftheextremeintheoldtrenddirection.Hence,understandingthefinaltestoftheextremeisfairlyimportantwhenidentifyingthefirstpullback.Itisalsothefailedtestbecauseitfailedtomakeanewextreme.Justtobeclear,thefirstpullbackisnotareversalset

up.Instead,itisawith-trendsetupthatentersthemarketataveryearlystageofthenewtrend–itisthefirstwith-trendentryimmediatelyafterpricehasreversed.Sometimes,onewouldbeinthemarketwhileotherswaitforconfirmation.However,whilemanywouldbeafraidtoenterthemarket,smarttradersunderstandthatthisisalowriskandhigh

rewardsetup.Infact,itisagreatandsafeentry.Ofcourse,itisalsoimportantthatyouhavesufficientCluesforSuccessbeforetakingaposition,wherewewillgothroughinmoredetail.

8.2FirstPullbackinNewDirection

Asweknow,whenthetrendends,itdoesnotimplythatthenewtrendwouldstartimmediately.Hence,itiscrucialthatyouneedtoknowwhatpriceactioncluestolookforwhenlookingforthefirstpullbacks.

Diagram8-3:TestingtheExtremeinOldDirection

Beforewesearchforthefirstpullback,Ithinkit’sworthtalkingaboutpriceactionrightbeforeithappens.Usingtheexampleabove,themarketiscurrentlyinanuptrend(oldtrenddirection).Thefirstindicationofapotentialnewpullback(inanewdirection)iswhenyouseethefirstLH.ThisisbecausetheLHisasignofweaknessthatisshowsthat

thebuyersarenotcompletelyincontrol.Asdiscussedearlier,thisisalsoapotentialfinaltestoftheextremehigh.Buyersaretestingtoseeiftheycanmoveanyhigher.Meanwhile,thesellersarekeepingacloseeye,oncetheyknowthatbuyersareexhausted,bigsellerswouldtakecontrolofthemarket,andtheywouldpushpricelower.However,

theconfirmationofthefinaltestrequiresaLLor,inthiscase,abreakbelowPointC.

Diagram8-4:FirstPullbackinNewDirection

WhenyouhaveaLH(theNewCinthediagramabove)andwhenpricebreaksbelowPointC(theNewBindiagramabove),theinterestingpartaboutpriceactionisthatitisalsowherethefirstpullbackinnewdirectioniscompleted.Inotherwords,youcanthenfindanewABCDinthenewdirection.Incaseyouhaveforgotten(as

mentionedinSection5.1),BCistheactualpullbackbutapullbackmustincludeCDwhereDmovesbeyondBorthepullbackisinvalid.Thesameapplieshereand,hence,pricemustmovebelowtheNewBforconfirmationofthefirstpullbackinthenewtrenddirection.Onceyouhaveafullcycle,thechancesarehigherthatthemarketisnowina

downtrend,andthechancesarenowslimmerforpricetomoveupwardsorsidewayssincethedownwardmarkethasalreadystarted.

8.3CombiningCluesforFirstPullbacks

Sothatwasit.Thefirstpullbackisnowontheway.However,understandingthefirstpullbackmeansnothingifyoudonottakeanypositions.Youeithercatchthenewpullbackoryoumissedit.Truthtobetold,thereisnothingmuchyoucandoaboutitonceyoumissarun.

Asyoucansee,tradingisaboutpreparationandthemoreyouarepreparedforit,themoreyoucangrabahighprobabilitytrade.Hence,thissectionhelpsidentifythecluesforsuccessforcatchingthefirstpullback.WediddiscussthecluesforsuccessinSection7.1andsomeofthosecluesareapplicablehereaswell.However,aswecontinueto

digdeeperintothenatureofthefirstpullback,Iwillsharesomesimplewayswhereyoucancombinecertaincluestoachievingevenhigherprobabilitiesofsuccess.

8.3.1ConvictionofaFailedPullback

Diagram8-5:PullbackFailsinOldDirection

Here’saquickreminderofhowpullbacksfail.Lookingatthediagramabove,wecanseethatpricebreakbelowPtAandthatisaconfirmationthatthepullbackhasfailed.ThisisalsothefirstLLthatwewerelookingfor.Whilewedon’tknowwhathappensnext,wecanonlywaitformorepriceconfirmationtoshowusifthebuyersorsellersaretaking

thelead.Nonetheless,theonlythingthatwearecertainistheoldtrendhaslostitsdriveandthatisanimportantcluetonote.SeeSection6.2fordetailsoffailedpullbacks.

Diagram8-6:TrendBarshowingconfirmationofFailedPullback

Whileafailedpullbackisimportant,weneedtheprobabilitiestostackinourfavour.Hence,intermsofpriceaction,youwanttoseeaclearbreakbelowPointAandoneofthebestwaystoidentifyseller’sconvictionisbyfindingoneormorelongbodiedbearishtrendbarbreakingthroughpointA.Thisisastrongconfirmationthatthepullbackhasfailed

andtheprobabilityofgettingafailureofafailedpullbackhasgreatlyreduced.SeeSection7.1.2fordetailsoftrendbars.

8.3.2SpottingBigPlayersatMarketExtremes

Marketextremes,relatestothefactthatpriceisprettyfarfromaverageormeanprice.AsmentionedinSection6.4,thefinaltestofthemarket

extremeisagoodindicationthattheoldtrendisendingand,hence,itisusefulinpickinguppotentialpullbacksinthenewtrenddirections.However,tomaximiseapullbackatapriceextreme,tradersshouldtrytheirbesttounderstandtimeframecorrelationbecause,sometimes,thepatternsareonlyobviousatrelevanttimeframes–usuallythe

largerone.Forexample:

-Apriceextremeatthe60minutechartismorerelevantwhentradinga15minutechart-Apriceextremeatthedailychartismorerelevantwhentradinga60minuteor4hourlychart-Apriceextremeattheweeklychartismorerelevantwhentrading

dailychartJusttobeclear,thetimeframeofyouranalysisshowswherethebigplayersareheading.Meanwhile,thetimeframebelowthatshowsyouthepatternorpullbackthatyouarelooking.Althoughthismightnotalwaysbethecase,theprobabilityofsuccessincreasesonceyoumastertheabilitytospotthebigplayers(usingtimeframe

management).

Diagram8-7:SilvershowingMarketExtremeonDailyChart

LookingatSilverinthediagramabove,youcanseefromthedailychartthatpricewasveryfarawayfromthemovingaverageline.Pricestayedfarawayfromthelineandevenclimaxed(boxed)atthetop.Thatwasconsideredtheextremesinceitwasatthepointwhereitwasfurthestawayfromtheaverageline(redline).

However,therewasnoclueshowingthelackofbuyersuntilwesawthefirstlowerhighinthe4hour.

Diagram8-8:SilvershowingFirstPullbackon4HourchartnearDaily

Extreme

Usingthedailycharttoidentifythemarketextremeasyourclue,youcanthenmovetothe4hourcharttopinpointwhenpricepullbackfailsintheinitialtrenddirection.ThediagramaboveistheboxfoundinDiagram8-7.Asyoucansee,thefirstcluethatthebuyershaverunout

ofstrengthisthepriceactiondoubletop–afinaltestoftheextreme.Then,itwasfollowedbyaLL(bar1)aswellasaLH(bar2).Theconfirmationofthefirstpullback(circled)inthenewtrenddirectionwaswhenpricebrokebelowbar1.Ifyoustayedonthedailytimeframe,youmightnothavespottedthepullbackandwouldhavemissedagood

pullbackentry.

8.4OtherFormsofFirstPullbacks

Ihopethedescriptionsofthefirstpullbackhavebeenreasonablyclear.Thefirstpullbackisoneofthebestpullbacksinapriceactionsetupandtradersshouldlearntoidentifythemwhereeverpossible.Onthatnote,herearemoreexamplesofpriceactionpullbackswhichcanbefound

indifferentpatterns.AsIamanadvocateoftradingpriceaction,IwouldencourageyoutounderstandwhythefollowingsetupsaregoodinrelationtopullbacksandIhopeitdoesnotturnouttobeanexerciseofmerelymemorisingthepatterns.

8.4.1ReversalPatterns

Sinceafirstpullbackisanearlyentryinanewtrend,it

shouldbenosurprisethatyoucanfindmanyfirstpullbacksimmediatelyafterareversalpattern.Hence,Ibelieveitisworthexploringsomeconventionalreversalpatterns.Justtobeclear,aswith-trendtraders,theideaisnottotradethereversalpatternsanditisimportanttowaitforpricetohavereversedbeforelookingforanyfirstpullbackentry.

Onaseparatenote,thereisnothingwrongwithtakingareversaltradebasedonreversalsetups.However,thisbookisabouttradingwiththetrend,anditshouldbeclearthatthesereversalpatternsareonlyusedascluesratherthensetups.Hereareexamplestoillustratehowonecantradethefirstpullbackinreversalpricepatterns.

DoubleTop/BottomandNecklinePullback

Diagram8-9:DoubleTopNecklinePullback

Asshownabove,adoubletoppatternisagoodandsimpleindicationthatthepricehastestedtheextremeonelasttimeandresultedinafinaltest,intheoldtrenddirection.However,asawith-trendtrader,thedoubletopisonlyapotentialstartofanewpullback(A)andthecluesthatyoushouldbelookingforarethenewlowerlow(B)andanewlowerhigh(C).

Theretestofthenecklineisanextrabutpowerfulclueasitiswheretheoldsupportbecomesresistance.Inotherwords,thedoubletopisonlythefirstclue,butnotaconfirmationthatafirstpullbackisready.Adoublebottomwouldactinasimilarbutoppositefashion.RangeMarketBreakoutsArangemarketcanhappenaroundthemarketextremeor

inthemiddleofatrendingmarket.Itisprettyimportantthatthetradershouldidentifythebiggerplayers(asdiscussedinSection8.3.2)beforehavingamarketbias.Asyouareaware,arangemarketisonlyformedifthereare2touchesoneithersideofthemarket(thisisrequiredtoformtheceilingandthefloor)andtheseareimportantcluestoconfirmarangemarket.

Arangemarketcanbesomewhattricky.Hence,ifyou’renotcertainoftheclues,itmightbeworthkeepingalogofitforafewtimesbeforeactingonit.Onceyouhavearangemarket,watchoutforfailedorfalsebreakouts.Unlessyouarearangeorbreakouttrader,with-trendtradersusuallystayasideuntilwegetsufficientpriceactionclues.

Diagram8-10:RangeMarketBreakoutPullback

Asyoucanseefromthediagramabove,PointBisthe

firstlowerlow,anditisalsothefirstbreakoutsidetherange.However,Bcanalsobeafalsebreak,andyoucanonlyfindoutifitisbywatchingCandDclosely.PointCisthefirstlowerhighandalsoaretestoftheresistance(previoussupport)level.Likeallotherpullbacks,thefirstpullbackisonlycompleteoncewehaveD,whichisthebreakbelow

BtoformasecondlowerlowandalsoacompleteABCDpattern.Ifthiswasatamarketextreme,pointAcouldpotentiallyactlikeadouble(ortriple)topwhichisalsothefinaltestoftheextreme.Ontheotherhand,ifthemarketwasinadownwardtrend,thenpointAcouldbeadoubletopbearishcontinuationpullbackpattern.

Eitherway,donotgettooboggeddownwiththeterminologiesbecause,ifyoudo,thechancesarehighthatyoucanmisslotsofprofitabletrades.Instead,readpriceactioncarefullyandunderstandthebiggerpicture.Whenpricechangesfromasidewaysmarkettoatrendingmarket,theconsolidationmarketactsasaspringwhereinvestorsarereadytoburstoutaftera

periodofindecision.H&SNeckline

Diagram8-11:Head&ShoulderPattern

TheHead&Shoulder(H&S)patternisaclassictripletoppatternand,likeadoubletop,itisalsoagoodsignofpriceexhaustion.Asshownabove,anH&Spatternwouldconsistofthreetopswheretheleftshoulderisthefirsttop,theheadisthesecond(andhighest)topandtherightshoulderisthethirdtop.Thetwolowsinbetweenthethreetopswould

determinetheshapeoftheneckline–asitcanbeahorizontaloraslopeneckline.Inahorizontalneckline,theentireH&SpatternreliesonthefactthatDmustbebelowB,whichisalsobelowtheneckline.Withthat,thenecklinecarriesquiteabitofprobabilityweight.Ifpricefailstobreakbelowtheneckline,thiscouldturnout

tobeadouble(oreventriple)bottombullishcontinuationpullback.ElliotWave

Diagram8-12:ElliotWaveTheory

TheElliotWaveTheoryisatechnicalanalysistool

developedbyR.N.Elliottandthetheorysuggeststhatthebasicwaveprinciplescanbedividedintotwomaincategories–ImpulseandCorrectivewaves.Accordingtothetheory,herearesomekeyrulesthatR.N.Elliotdeveloped:

-Impulsewaveshasa5-wavesequence(wave1-5–seeabove)-A3-wavecorrective

sequence(waveABC–seeabove)followsaftertheimpulsewaveends.-Wave2cannotretracebeyondwave1-Wave3isthelongestamongstalltheimpulsewaves(wave1,3and5)-Wave4canneveroverlapwave1

Asyoucansee,accordingtotheElliotWavetheory,catchingfirstpullbackinthe

impulsewavehappenstobethemostprofitablesetupsincewave3isthemother(longest)ofallwaves.Ontheotherhand,thefirst5wavesservesasaclueinpreparationforthefirstpullbackintheoppositiondirectionandthatiswaveCinthecorrectivewavesequence.Note:ThesearejustbriefextractsofElliotWaveTheoryto

showthatthefirstpullbackcanbeappliedandisinlinewiththeElliotWaves.However,thissectionisnotdesignedtoteachorexplaintheuseofElliotWaveTheory.

8.5KeyPointsHerearethesummariesandkeypointersforthissection:

-Thebestpullbackisthefirstpullbackinthenewtrenddirection.Sinceitisdifficulttopicktopsandbottoms,tradingthefirstpullbackprovidessetupsthatareneartopsandbottoms.-Cluesbecomemorepowerfulwhenyoustart

combiningmorethanoneofthem.Thetwomaincombinationdiscussedinthissectionincludes

-Identifyingconvictedfailedpullback-Identifyingbigplayersatmarketextremes

-Reversalpatternsaregreatsignalsinadvanceofthefirstpullback.Hence,itisusefultoknowthem.

However,learntopickupcluesforsuccessinthosepatterns.

9BuildingaCase9.1StackingProbabilities

DoubleTopNecklinePullback

Diagram9-1:DoubleTopNecklinePullback

ThediagramaboveshowstheEURUSD60minutechart.Bar1and3showsadoubletoppatternbeforepricestartedmovingsouth.Thatwasalsoagoodenoughindicationforpricereversal.Bar2wasagoodleveltodrawthenecklinebecausethatwasthepriorlowbeforethedoubletop(Bar1and3).Meanwhile,whilebar4

seemslikeafalsebreakoutinitially(asafalsebreakoutcanhappeninsimilarsituations).However,bar5showedsellers’convictionasthelongtrendbarpushedpricebelowthenecklineandbelowbar4withcertainty.Italsoformedaconvincinglowerlow.Oncebar5gavetheconfirmationofthelowerlow,traderswouldwaitfor

thefirstpullbackafterthelowerhighandtheretestofthenecklineatbar6.RangeMarketBreakouts

Diagram9-2:RangeMarketBreakoutPullback

TheaboveistheEURUSDcurrencypairona4hourchart.Asyoucansee,bar1&3formedtheceilingoftherangemarketandbar2&4formedthefloor.Sincethiswasamarketextremeonadailyorweeklychart(notshown),thiswouldhavebeenagoodplaceforsellerstowaitforthefirstpullbackinthenewdirection.

Buyerswhodidnotspotthatwouldhaveplacedtheirordersslightlyabovebar1foradoublebottompullbackbuttheirorderswouldnothavebeenfilled.Thefirstclueofashortwaswhenbar5brokebelowthefloorandbar4,thatwasalsoanicetrendbarshowingsomeconviction.Breakouttraderswouldhavetakentheshortatbar5,butwith-trend

traderswouldhavewaitedforthefirstpullback(incasebar5turnedintoafalsebreak).Bar6wasafailedfalsebreakout–sincethebuyersattemptedtopushpricehigherbackintotherangebeforethesellerstookchargetosendpricebackoutoftherangeagain.Trendtraderswouldviewthisasafailureofafailedpullbackinthenewdirection.

Irrespectiveofwhatthepatternwascalled,themarketplayersweretryingtooutsmarteachotherbytestingthemarketonbothdirections.Fortunately,thesellerstookthefinalcontrolofthemarketatbar6andpushedpricebelowbar5,andthatwastheconfirmationofthefirstpullback.

H&SPatternHead&Shoulder(H&S)patternsarefairlychallengingtospot,andit’susuallyeasierinhindsight.However,onecanexpectittoappearifitisneartheextreme.

Diagram9-3:GBPUSD(4Hourchart)showsH&SPatternwith

HorizontalNeckline

Theaboveisonechartthatwouldhavekickednewtradersoutofthemarketforavarietyofreasons.Lookingatthechart,bar2wouldhavebeenadecentflatpullbackbutwith-trendtraderswouldbetooeagertoenteratbar2.Instead,abreakabovebar1wouldhavebeenasafeentry–whichitdidatbar3.

Bar3wasaTrendbar,anditwasthefirstconfirmationoftheflatpullback.Unfortunately,pricedidnotfollowthrough.Whenyouseethatthebullshavenotfollowedthroughafterbar3,tradersshouldbecarefulthatasthisisthefirstsignofbuyers’weakness.Itwasalsoagoodcluethatwouldleadtoapotentialcomplexpullbackorevenafailedpullback.

Throughtheuseofasmallertimeframe,somewouldarguethatBar4testedthelowofbar2andtheyformedadoublebottom.Thatbecameadoublebottompullbackassoonaspricebrokeabovebar3.However,basedonthetimeframethatisshownabove,thatwasnotobviousenoughandwecanjustassumethatitwasonlyasimplepullbackpattern.

Thetrendbarafterbar4wasanotherindicationthatthebuyerswanttotakecontrol.However,itdidnottakelongbeforewesawpriceconsolidatingandbar5wastheconfirmationthatthesellerswerestrongtoo–abearishtrendbarwhichisalsoanengulfingbar.Thebuyerscamebackforthe3rdtimeatbar6.Atthisstage,itwasclearthat

themarkethadnodominantleaderandbuyers/sellerswereequallystrong.Smarttraderswouldbeextracautiousfromhereon.Assoonasbar7madeanewhigh(thoughitwasnotabovebar5),itwasclearthatbar4and6hadmadeadoublebottom.Infact,sincetheywereatsimilarpricelevel,thedoublebottomformedadecenthorizontalsupport.

Bar8brokebelowthesupportlevelbutfailedtoholdonbelowit.Thiswasatestofthelevel,anditwasalsoaconfirmationthatthesupportheldonwellatthatpricelevel.Somebuyerswereexcitedasthiswasalsoareasonableindicationthatthebuyerswereincontrol.However,whilethiscouldbeanearlyclue,theconfirmationofatrendcontinuationonlyhappens

whenpricebreaksabovebar5andthatiswhenpriceshowsanewhigherhigh–unfortunately,thatdidnothappen.Afterbar8,thestringofdojibarswasanotherconfirmationthatneitherthebuyersnorsellerswereincontrol.Asthosedojibarsformedasmallrangemarket,breakouttraderswouldhavetakenthebreakabovebar7

asasetupbutthatturnedouttobeafalsebreak.Sellersjumpedintoitassoonasitfailedandpushedpricefurtherdownfrombar9.Fromthatpointonwards,pricejustwentlowerandlower.Sellers’showedconvictionwhenpricebrokebelowthedoublebottomsupportlevelaswellasbelowbar8.Ontopofthat,thelowofBar8

waswherebuyersplacedtheirprotectivestops(whichweresellorders).Assoonaspricewentbelowbar8,thoseprotectivestopsgottriggeredinandfuelledthebearishmoveevenfurther.Bothbar7and9weretestsoftheextreme(whichwasthehighofbar5),wherebar9wasthefinaltest.Themovefrombar8to9wasthefirstpullback,buttherewasno

confirmationuntilpricewentbelowbar8.Unfortunately,thiswasacomplexpullbackwithinanH&Spattern–withbar3astheleftshoulder,bar5astheheadandbar9astherightshoulder.Infact,theH&Spatternwasnotconfirmeduntilitreachedbar10.Withsomuchindecision,thehighestprobabilitytradewasatthebreakbelowthe

neckline.Alternatively,traderswouldhavetakenthebreakbelowbar8sincethatwasthenewlowerlowandthatasalsothefirstpullbackinthenewdirection.Newtraderswouldhavebeentrappediftheyhadenteredwhenpricewentbelowbar6andtheywouldhavestayedaway.Thenextpullbackafterthatwasatbar11.Thiswasa

shallowpullbackaftertheconfirmationoftheH&Spattern.

9.2KeyPointsHerearethesummariesandkeypointersforthissection:

-Beforeyoutakethefirstpullback,constantlylookforcluesthatwouldsupportyourdecision.Themorecluesyouhave,thebetterchancesofsuccess.-Whenthereisnoclearleaderinthepriceactionwar,it’salwaysbesttostayoutofthemarket.

-Firstpullbacksarehighprobabilitytrades.However,thereisnoguaranteethatthefirstpullbackalwayswin.Allyouknowisthatitcanbeprofitableinthelongtermifyoutradewithmultiplecluesforsuccess.

10Mastery–What’sThatAllAbout?

“Apersonhas“mastered”aparticularareaofskillwhenheorsheisabletohavebothconsciousandunconsciouscompetencewithrespecttothatskill.Let’stakeforexampleawoodcarver.Knowingthetechniquesofbeingagood

woodcarvermaymakeapersonagoodtechnician,butdoesnotnecessarilymakeapersona“master”.Inthissense,masterycanbecontrastedwithtechnical“competency.”Inadditiontobehaviouralcompetence,themasterknowstherulesofwoodcarving,theelementsthatguidetherules,andhasintuitionsaboutwhatiswell-formedintheprocessofcarvingwood.Masterycan

alsobecontrastedwithartistry(thenextlevelbeyondmastery)which,accordingtoGregoryBateson,istheprocessof“bendingtherules”inawell-formedway.Themasterissomeonewhoisbeyondbeingatechnicianandwellonhisorherwaytowardsartistry.”–NLPUMastery,foramarkettrader,goesbeyondtechnicalknow-

howandmonetaryachievements.Ofcourse,majorityoftradersIknowareinitforthemoneyinitially.However,asyoucontinuetoachieveyourfinancialgoals,tradingbecomesmorethanjustwealthachievements.Formany,itbecomespartoftheirlivelihood,andtheyfeelratheruncomfortablenotstayingintouchwiththemarket.

Ifyoutrulywanttobecomesuccessfulintrading,Istronglyurgethatyoutoworktowardstradingmastery–asopposedtohavingwealthobjectivesonly.Learningtotradethemarketrequiresyourcommitmentthatgoesbeyondwealthbecauseonceyouareamasteratit,achievingwealthiseasyandeffortless.Aboveandbeyondthat,don’tjusttakewhatIsayorwrote.

Infact,challengeeverythingthatIwroteinthisbook,becauseunlessyoudothat,achievingmasteryisjustanotherfancywordthatyoujustread.Agoodwoodcarverstartedoffbygettinghis/herhandsdirtybeforeknowingwhatrulesarerelevantandwhatrulesarenot.Becausehe/shehaspracticedtheskillssomanytimes,he/sheisabletoapplyalltheruleseasilyand

effortless,andthatwaswhenbendingtherulesbecamepossible.Ibelievesomeusefulpointerscanhelpyougoalongwayandthatiswhatthissectionisabout.Thefollowingaresomeareaswhichisimportanttoachievingtradingmastery.

10.1FourStepstoMastery

Iwon’tbesurprisedthatsomeofyouwouldstartapplyingthetechnicalsetupsinthemarketimmediately.Infact,Ihopeyoudo,becausethefasteryoustartapplyingit,thefasteryoucanstartmakingmoney.Nonetheless,masteryisajourney.Morethanthat,youalsoknowthatachieving

masterywouldrequirethetradertoapplythesameskillsoverandoveragain.Thisisthesimpleideaofrepetitionworksbecauseeachtimeyouharnessthesameskills,youapplythoseskillsbetterthanthelasttimeyoudidit.Essentially,itistherepetitionthathelpsyoubecomecompetent.Whileitisnotcrucialtoknowthesesteps,knowingit

ishalfthebattle.Ihavemetmanyimpatienttraderswhoneitherappreciatenorunderstandtheimportanceofrepetition.However,readingthisrightnow,youknowyoucanstandoutsuccessfullytobeawinner.Inordertohelpyouunderstandtheroadtomastery,Ihopethefollowingstepsareuseful.UnconsciousIncompetence

Rememberthefirsttime

youopenachart,yourealisedthatitseemslikeseeingabunchoflineswithfancycolours,andnothingmakesensetoyou.Thisiswheremostofusstartedourtradingcareerascompleteamateurs.Youventuredintothetradingworldhopingtogainnewwealth,andyoumay(ormaynot)havesoughtafter

variousresourcesinthehopeoflearninghowtotrade.Atthisstage,youwerecluelessastowhatresourceswereusefulandwhatwerenot.Someofyouwouldhaveinvestedintradingcourseswhilesomehavereliedonbooksandpublishedmaterials.Eitherway,inthisfirststageoftrading,youdon’t

knowwhatyoudon’tknow.

ConsciousIncompetenceOnceyou’vecollectedyourresources,youstarttolearnsimplepriceactionortradingsystems.Someofyouwouldhavelearnedspecificskillsifyoujoinedacourse.However,mostofyouarestillconfusedwhenyouseeachartfullof

candlesticksorbars.Whileyoustarttolearnthebuildingblocksofpricecharts,youstruggledtomakeanysenseoutofit.Asyoucontinuetoacquirenewknowledge,youstarttofluctuatebetweenbeingunconsciousincompetenceandconsciousincompetence.Eachtimeyoulearnanew

toolandtrytoapplyitinthemarket,yourealisethatthereisagapinknowledge,oryoumayfindthatthereis‘something’lacking.Youthengetbacktoyour‘library’inthehopeoffindingmoreresourcestolearnmore.Thisisthestagewheretradersaremostcuriousand,here,youcanexpect

asteeplearningcurve.Thisisalsothemostchallengingstageasitiscanbethemostemotional(forsome).Theimpatientonesareeagertostartusingrealmoney.Unfortunately,mostofthemloseit.Don’tbedespairbecausethereisalwaysconfusionrightbeforeanygrowth.Atthisstage,youknow

whatyoudon’tknow.ConsciousCompetence

Thiswheretherealtradingdevelopmentbeginsbecause,atthisstage,youhavelearnedenough.Byenough,Imeanthereissufficientknowledgeinsideyoutokeepyourselfgoing,andyouconsciouslychoosetostoplearninguntilnecessary.Infact,youstarttorevisitall

thelessonsthatyou’vehadorkeptthroughoutyourtraininginthehopeoffillinganygapsthatyoumayhave.Moreimportantly,yousuddenlyrealisethatyouhaveclarityoveralltheworkthatyou’vedonesinceyoufirststartedtrading.Youunderstandwhatyoudidwrongandright,youstartto

appreciatethattradingisaprobabilitygame,yourecognisetheimportanceoffollowingtheprocessandyoulearntostopchasingtrades.Theseareonlysomeofthesignsthatyouarenowconsciouslypickedup.Whileyoumaymakesomeoccasionalmistakes,youarenowawareandconsciousofwhatis

requiredtobeasuccessfultrader.Hence,youworktowardsyourbeliefs,andyoustarttoapplywhatyouknow.

UnconsciousCompetenceAssoonyougetpassthepreviousstage,thefinalstageislikedrivingacarwithyearsofdrivingexperience(assumingyoudriveacaronadailybasis).Everythingyoudo

–fromputtingonyourseatbelttousingyourleftorrightindicators,andfrompressingonthebreakstotheaccelerator–theyarenowperformedatanunconsciouslevel.Mostofthetime,youdon’tevenrememberwhatyoudidwhenpromptedbecauseitisnowahabit.Thisiswhereyouknowyouareunconsciously

competent.Fortraders,youwanttobeabletoplaceatradewithoutsecondguessingyourself.Youaremanagingyourtradeswithouthavingtodebateinternallywhatyouareabouttodo.Makingadecisiontotradeiseffortless,andyouknowyourtradingrulesinsideout.Moreimportantly,

youknowthattheonlywaytogainwealthisthroughflawlessexecutionanddiscipline.Here,youapplywhatyouknowwithoutthinkingaboutit.Thisistheultimategoalofalltraders–tobecomeanemotionlessandmechanicaltrader.

10.2TechnicalMastery–TheJourney

Nowthatyou’vegottenabetterviewofhowpullbackscanworkinyourfavour,Ibelieveitiswisetothinkaboutwaysyoucanincorporatethemintoyourowntradingroutine.Moreimportantly,youneedtoconsiderhowyoucanleverageonthisknowledge.Ifyouwanttointegrate

marketpullbacksintoyourexistingtradingsystem,startoffwithafewrulesandtestyournewsystemthroughbacktesting,forwardtestingorboth.Ifyoudecidetohavemarketpullbacksasastandalonetradingsystem,thencreatesomerulesbasedonyourownpersonalityandproceedtotestitaswell.Whicheverwayyoudoitisfine,buttheonlywaytofigureoutwhichisthebetter

optionisthroughsheeramountofpracticeandsomelogicalthinking.Sincepullbacksworkonanytimeframes,besuretopickthetimeframethatsuitsyou,yourscheduleandthefrequencyyouwanttotrade.Rememberthatyoucangetmanymoresetupsona5minutechartcomparedtoadailychart.Makesurethatyou

thoroughlyunderstandhowmarketpullbackswork,whentheyworkand,moreimportantly,whentheydon’twork.It’slikelearningtodriveacar.Nomatterhowgoodyouthinkyouareindriving,itwon’tbesafetodriveunlessyou’vetakenaminimumamountofpracticeontheroadinasecureenvironment(i.e.withaninstructor).Inthecaseoftrading,thatwouldinvolve

tradingonademoaccount,testenvironmentorjustasmallaccount.Onceyoustartapplyingtechnicalanalysisandtechnicalpullbacksjustlikethewayyouhaveaconversationwhiledriving,andyouarecompletelycongruentwithyourdecision,youknowyouarealreadyinthejourneytowardstechnicalmastery.

10.3MindMastery–TradinginTheZone

Atrader(andnowafriend)oncetoldmethattakingatradeislikeDavidBeckhamtakingapenalty(kick)intheChampionsLeagueFinalsorlikeTigerWoodsteeingoffintheU.S.PGA.WhenDavidgetsintothepenaltyboxoreachtimeTigerdrivestheballfromthetee,theyadjustandpre-framethe

mindsetthattheywant.Theyrehearseintheirmindtheirplanofattackandtheysee,hearandfeelwhattheyareabouttodobeforetheydoit.ThisiswhereDavidorTigergoesintothezone–aplacewheretheyareintheirwinningmindset.Whiletheydon’tknowwhathappensaftertheyattacktheball,itdoesn’tmatter,andit’snotimportantbecauseallthey

reallywanttodoistofocusonNow.SomepeoplecallthisTradingintheZonewhileothersjustacknowledgethatyouneedtohavetherightstate-of-mindtotrade.Whateveryoumaycallit,youneedtolearnhowtofindandbeabletodrawoutthestate-of-mindwhereyouaremostconfident,mostrationalandmostrelax.Moreimportantly,youneedtobe

abletobringoutthatstate-of-mindeachtimeyoutradethemarket.Thisisimperativetohelptradersfocusonwhatisimportantbecausedecisionsthattheymakewhentheytradethemarketshouldbelogicalandunbiased.Inagist,thisismindmastery,and,believeitornot,itisthemostvaluabletoolinyourtradingcareer.Hence,make

suretopracticeandworkonitonadailybasisuntilyoumasterit.

11FurtherDevelopment

Thankyouforpurchasingthisbook.Thefactthatyouarereadingthissectionnow,itmeansthatyouprobablywanttodevelopyourtradingskillsfurther.Ifyouwanttoexploretheideaoftradingmarketpullbacksseriously,orifyouwanttoincorporateit

intoyourowntradingroutine,Iwouldliketoinviteyoutovisitwww.MarketApprentice.com,whereyoucanlearnthestepbystepapproachoftradingthepullbacks.Ihavespentagood8monthswritingthisbookandI’vecometotheconclusionthatlearningtotradecanbemademoreefficientthroughtheuseofothermediums.Learning

shouldbeinteractiveandthatcanbedonewiththeadvancementoftechnology.Hence,I’vecreatedMarketApprenticehalfwaywritingthisbook.BesidesTechnicalAnalysis,MarketApprenticeofferstradingprogramsonMindMastery.Traderscanlearntotradeusingtheconsciousandunconsciousmind,thus,allowingtraderstomanage

yourownemotions,disciplineandselfcontrolatamuchmoreprofessionallevel.IhavedevelopedthesecoursesafterreceivingintensivetrainingintheareasofNeuroLinguisticProgramming(NLP)andHypnosis.MarketApprenticeisanonlinetradingacademydesignedtohelpserioustradersapproachthemarket

withsupportandguidance.Ifyouareseriousabouttrading,thenmakesuretocheckouttheacademybecauseyoumightbecomeanApprenticetradersoonerorlater.Ifyoulikethisbookandwantotherstoenjoywhatyouread,doconsiderleavingapositivereviewonAmazon.com.ThisisalsoimportantbecauseIhavehadsomenegativereviewsfrom

unverifiedbuyerswhoaredeliberatelytryingtodiscreditsotherreviews.WhileIcontinuetofindwaystoremovethem,Iaskforyourreviewtocounterthemtoo.Topostareview,youcandosobyusingthelinkthatwassenttoyouwhenyouboughtthisbook.BecauseAmazonissocompetitive,yourpositiveratingcountsevenifyou

decidetokeepitshort.Lastly,thankyouverymuchforyourtime.Iwishyounothingbutsuccess,andIhopetoseeyousoonatwww.MarketApprentice.com.Regards,AlwinNgTrader&[email protected]