When to take retracement/pullback signals

Trade Entry

This would be the 5th article of my strategy, if you haven had a chance to read them, please do, you’ll get a much deeper understanding about what you are about to learn.

Here are the links:

Important aspects of my strategy
Market Dynamics: How the market moves
When to go Long and When to go Short
How to find profitable Breakout Signals

You’ll learn so much from those articles that will change the way you see and trade the market, so please make sure to give them a quick read.

What is Retracement/pullback signal?

I’m sure you have heard traders say something like:

I’ll wait for a pullback, then I’ll trade it!

Well, a retracement or pullback trade happens when the market breaks through an important range or level, then it comes back to “test” that level again (or the breakout).

The market goes like this:

retest

It breaks through an important level, then it comes back to test that level again… if the market breaks that level back, it would be a false breakout, and the market will trade again inside the range.

But if the market gets rejected from that level, it will confirm the breakout and it could give us a retracement signal.

Now, let me ask you this question:

Are you supposed to take every retracement signal?

Not at all.

In fact, you should only take a handful of them.

And that’s that this article is about, how to know what retracement signals to take.

In order to be valid signal we need three things:

  • Pressure
  • At an important level
  • Significance

Here is what I mean by each aspect of the signal.

Pressure

There are two types of pressure: upward and downward pressure. We have upward pressure when bulls take control over the market after bear dominance and downward pressure when bears take control over the market over the market after a period of bull dominance.

Try to picture this “pressure” on your head, what would it look like? It would look like a “v” shaped pattern as upward pressure or an “inverted v” as downward pressure. Let’s take a look at some images to make sure this is clear.

pressure

The first candlestick moves down (bear dominance – red arrow), but at some point, bulls gain confidence and take control over the market (i.e. bulls felt comfortable trading at those levels) pushing the market back up (bull dominance – blue arrow).

If we combine both arrows, we end up with a v shaped pattern (green arrow) with upward pressure.

Does it mean that only known candlestick patters (such as piercings, hammers, shooting stars, etc.) have either upward or downward pressure? NO. In fact, most patterns that have either upward or downward pressure aren’t known candlestick patterns. Take a look at the next image.

pressure2

This pattern is not known in the candlestick literature, but it still has upward pressure. You still see the “v” market movement.

Next time you see a candlestick pattern, try to picture it in your mind as “v” or “inverted v” pattern, this way you will train your brain to see them as price action, not just as a candlestick pattern.

At an important Level

Another important concept that describes Forex Price Action, is how the market behaves at a place it already traded before.

I suspect the reader already knows what we are talking about, if the market was rejected from an important level, the next time it comes close to that level, it is likely to get rejected again. And yes, we are talking about regular support and resistance levels.

This is the reason why we always need to pay attention on where the market has been rejected, specially the short term Support & Resistance levels, because at those levels we always should be ready to open our trades (in the direction of the long term market condition). Please take a look at the next chart:

level

In this chart, where would you open your trades? If I was to trade this chart, I would look for long opportunities around the bottom of the range, because the market gets rejected every time it gets near that level. And short opportunities around the top of the range, again, because every time the market gets close to this level the market gets rejected.

Significance

Due to the nature of the Forex market (OTC: over the counter), it’s impossible to get an exact reading of the volume of the market at any given moment. But there are certain measures that can be used as a “proxy variable”, one of them is the significance of the “pattern”.

The significance of the pattern refers to the size of the pattern that triggered the upward/downward pressure compared to the previous candlesticks.

If we are tracking a “long” signal, we need to compare the size of the pattern that triggered our long signal to the bear candlesticks that formed the previous downward movement.

And vice versa, of we are tracking a “short” signal, we need to compare the size of the pattern that triggered our short signal to the bull candlestick that formed the previous upward movement. Let’s take a look at some images.

significance

The trigger signal in the image above is clearly larger than any of the 3 previous candlesticks that formed the upward movement; therefore it is a significant pattern.

Putting it all together

Please take a look at the next chart:

all together

The pattern (orange square) with downward pressure is formed at an important short term resistance level (green line) and it is also significant (pattern larger than the previous candlesticks). This is considered to be a Forex price action signal to go short.

Your turn

What do you think about my the retracement signal?

Would you rather use the breakout or retracement signal?

Would you add anything else to filter out bad signals?

Please share your thoughts

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Raul Lopez

I've been trading the markets for more than 15 years. I believe the best way to trade is by adapting to the market conditions. You can learn it too, join our community .

  • Varahala Babu

    hi raul…can we look for long trades on aud/nzd ?

    • Raul Lopez

      Hello Varahala,

      From the long term perspective, it looks like it was rejected already from an important long term level…

      But there is something that keeps making some noise in the short term charts…

      Do you see a clear range there? Do you see the SF box? I dont, and that’s what is keeping me from taking any trades here…

      But again, from the LT charts, it looks like its heading up!

      Good luck!

  • Krishan Lal

    Results do vary from time to time as not every level is important for market. But I
    take lesser risk entries as fading extremes and fading candlesticks patterns or any continuation signal after retracement and that is How I see trading should be and we need to remain ahead of the market and thinks like pro to compete with the best of the lots.

    Thanks a lot for you effort. Really helps a lot to understand how to fade few breaks as this was a point of confusion for me.

    • Raul Lopez

      Yep, I certainly agree with that, we need to reduce risk, do our analysis, and focus only in the best opportunities out there…

      Good luck Krishan!

  • Krishan Lal

    Thanks Raul for putting it altogether. Irregular candlesticks patterns are more reliable and we need to consider the strengths of the pattern at important levels and specially if price go through the multi-month or yearly extremes tests are most likely and would consider to take much more signals on those scenarios.
    Your views…

    • Raul Lopez

      You are right Krishan, that’s one of the reasons I use the significance of the pattern as an important variable…

      Put all these three aspects together: pressure, at an important level and significance to work, and you’ll definitely see some results…

      Let me know what you think!

  • Denny Mursali

    Hi Raul,
    Would you consider to add DeMark trend line to filter for retracement ?

    • Raul Lopez

      Hello Denny,

      Thank you very much for your question…

      Personally I dont like to trade using trendlines, they tend to be a little subjective, we move and tweak them based on our “liking”

      I would rather use other filters, like the market condition, take a lookt at the second article that I mention at the beginning of this article, that’s definitely the best way to filter out bad signals.

      I’ve also written one specific article about why I dont like trendlines:

      http://www.protradingnow.com/2013/07/10/why-its-very-dangerous-to-trade-using-trendlines/

      Let me know what you think!

  • hira

    I prefer to trade both of them I call that orange box train trax and I like that as a trigger but most times its al ways better to get your zone you want to trade , near term longterm shorterm key levels ect and there you just wait for a sniper oppitunity if candlestick present it self clearly telling you to trade it …

    • Raul Lopez

      Hey Hira, thank you very much for your comment and sharing your strategy, it definitely adds to the conversation…

      Let me know if I can help you with anything else!

      • hira

        hey raul can I see this box of yours ?

        • Raul Lopez

          What box are you talking about?

  • Varahala Babu

    hi raul…i would like only breakout signal…because once the highest high or lowest low broken it would be other confirmation ..thanks

    • Raul Lopez

      Yep, that would be another confirmation…

      Retracement signals are good though, because it is here that the market is telling you that it doesnt want to go down/up, and that’s when you want to go long/short.

      Good luck!