The 3 Factors I Look for in Every Pullback Setup

Trading forex can both
be interesting and rewarding
if one can spend the time learning how
it really works. First you have to build a base. That includes developing a
strategy that works for you, finding a good money management strategy and
training your mind to be disciplined in all facets of trading. Remember, at the
end of the day you must muster up enough courage to pull the trigger for any
strategies developed to work

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What I will teach you in this article is a pullback trading strategy that
utilizes stochastics, simple support and resistance as well as Fibonacci
retracement ratios to time trades in the direction of the primary trend. In my
personal opinion, simple strategies work best in trading. And as simple as my
strategy appears, keep in mind that no system is a bad system as long as it
works and produces results for the owner. My honest advice is that you should
stick to what works for you. If your strategy produces more winners than losers
(as well as profits) stick with it but re-evaluate it from time to time because
market conditions might change so re-evaluations allow you to incorporate new
changes in the market you trade into your strategy.

Terminology I Use In This Article

Before we go into the discussion of this strategy, it is important for us to
understand the key words in this strategy. Don’t worry if you don’t fully grasp
the definitions below. They will become clearer when I walk you through my
strategy.

Stochastics is based on the rule that, within a period of strong market
action, a market will tend to close towards the upper end of the range, while in
downtrends, the price will close near the bottom of the range. Stochastics is
made up of two lines; %K and %D that oscillate between 0 and 100.

Overbought and oversold conditions are functions of this indicator which
could range between 80 on the upside and 20 on the downside. In addition,
stochastics sometimes generates a divergence condition, which occurs when the
indicator fails to confirm a move to a new price high or low in the price
action.

Support and Resistance. Resistance is a price level above the market
where supply is strong enough to overcome demand while support is a price level
below the market where demand is strong enough to overcome supply. Price action
is often contained with a ranges of support and resistance. A rectangle pattern
of tops and bottoms can serve as a good examples support and resistance levels.

Fibonacci Ratios are a sequence of numbers in which each successive
number is the sum of the two previous numbers: 1, 1, 2, 3, 5, 8, 13, 21, 34, 55,
89, 144, 610, etc. Leonardo Fibonacci, an Italian born mathematician around 1170
discovered the relationship of what is now referred to as Fibonacci ratios while
he was studying the Pyramid in Egypt. These numbers possess interrelationships,
such as any given number is approximately 1.618 times the preceding number and
any given number is approximately 0.618 times the following number. Fibonacci
level are relevant to traders because markets often bounce from key Fibonacci
price levels.

Candlestick bars are a way of displaying the relationship between opening
and closing prices during a time interval.

• If the close is higher than the open – the candle is white
• If the open is higher than the close – the candle is black.

Now that we understand the meanings of stochastics, support and resistance,
Fibonacci ratios and candlesticks, it is time for us to move into the
fundamentals of this strategy. Below are our parameters:

1. The strategy utilizes top-down approach in time frames starting from higher
time frames (weekly candlesticks) to lower time frames (weekly-60 min chart)

2. We look for overbought and oversold readings on the stochastics indicator
after a pullback in an uptrend and a rally in a downtrend.

3. We then watch price actions at our defined support and resistance levels to
see if it would hold or violate these levels

4. After establishing support & resistance, we will now plot our Fibonacci
ratios to determine which Fib levels coincide with support and resistance zones,
keeping an eye on the stochastic extreme readings.

5. We focus on signals that are going in the direction of the primary trend. We
do not take signals against the primary trends, whether downtrends or up trends.

6. Lastly, we use reversal candle patterns as our entry triggers. These reversal
candle patterns include hammers, bullish engulfing patterns and dojis.

7. Putting it all together: A close above the high of the previous day’s low
when the stochastic indicator crosses over from the oversold zone and is above
20 (reading) coinciding with our established support & resistance/Fibonacci
retracement and a reversal candlestick pattern gives us an entry.

Step One

Establish an uptrend (downtrend) on the weekly time frame. In this case, EMAs
(50,100 & 200) and trendlines are used to determine the direction of the main
trend. Below is a weekly chart of GBP/JPY cross. This cross has been in an
uptrend since 2000.

Step Two

After determining the direction of the trend on the weekly time frame, we will
drill down to the daily chart in order to establish the trend (in the direction
of the weekly trend) and also monitor pullbacks to know if it meets our strategy
as defined above.

As can be seen below, a pullback is already in place and price has moved into
our defined support zone as well as fib levels but we still need to drill down
further to 240-minute chart to see what price action and the stochastic
indicator are doing. If price is hesitating while stochastic is oversold, we
then look for a reversal candle and a bullish stochastic crossover above
oversold zone (reading above 20)


Step Three

On the 240-minute chart, price actually stalled at our defined support/fib
levels and a few ours later closed above the previous bearish candle to form a
bullish engulfing pattern. Also our stochastic indicator had already turned
bullish above the oversold zone on the formation of the bullish engulfing
pattern giving us an entry on the formation of the next candle.


Conclusion

This strategy works on both downtrends and uptrends provided its defined
parameters are followed. I use it as a swing trading strategy but for those
interested in using it for day trading a little adjustment might be needed.
Depending on how you want to utilize the strategy, either as day trading or
swing trading you can set your exit points based on your preferences but for me
I like using trailing stops. As stated in the beginning, Simplify, simplify,
simplify are the words I read every day as I begin my trading day. I love simple
strategies because they work.

Mohammed Isah is a private trader and an independent technical analyst. He
initially traded stocks and now primarily focuses on forex. You can contact Mohammed on his pivot points
reports and other inquiries at: isahmo@gmail.com.

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