Finding an edge in trading is not easy and if you consider how markets actually move, you can make that a little easier and pullbacks should be considered.
Markets, regardless of the instrument, have a basic movement of consolidation, breakouts, momentum moves, mean reversion, momentum…..it keeps playing out.
Just as important as the setup is what a failure of the trading setup looks like. While not the topic of this post, know that failures of price patterns can often be a trade themselves. They can be great trades as other traders are caught on the wrong side hoping for price to come back.
Knowing what should happen during your trading setup is also important so let’s take a look at one of the Forex pairs I mentioned in my free weekly Forex signals and setups.
EURCHF Currency Swing Trade Setup
The setup was a pullback in a market that was making higher highs and higher lows which is the definition of an uptrend. Being a swing trader, these are the moves I look at even though the overall trend could be considered a down trend especially if we consider the move off of highs back in May
One thing to point out is this move off of lows could be a complex correction and if you ignore the spike lower on the left, we have a perfect A-B=C-D. Still, considering price action itself, I wanted a move up from this area.
This area is the previous resistance area so I was considering a breakout – pullback scenario. Given that, the right side of the chart was given consideration as a simple pullback. Price pulled back in “lazy” fashion and that is something you’d want to see if considering a pullback trade.
Pullback Failure – Takes Long Trades Off The Table
Here is the current chart of the EURCHF and as you can see, the pullback failed to materialize.
When trading pullbacks, you want to see price drift to away from highs (in this example). We do not want to see any sign of strength in the opposite direction in the way of momentum against the pullback.
That is what happens in this example. Price ranged, which can also be considered a failure (I usually turn from pullback trading to a breakout trade in those cases) and then broke to the downside.
Let’s play devils advocate for a second here and consider something else could be in play. In trading, having several scenarios can actually have you making money while other traders gave up on a position.
What if what we are seeing is a breakout, pullback, and then price breaking back under former resistance (now potential support) to simply washout weak longs? After all, traders are told that if a breakout comes back below (or above) the breakout zone, the trade has failed.
That is not true.
Breakouts can pull back below (in this case) seeking order flow in an effort to sustain a run in price. When those that were long on the first breakout exit, they sell which drives the market into other zones.
Complex Correction or Resumption of Down Trend?
I’ve marked off in blue what could be a sloppy complex correction and given the momentum that happened on the breakout, it is possible that is what this is.
If you follow the white line at D, it pulls us over to an area inside of the red A-B-C area where price ranged and the breakout found the gas to happen. You can see the price action at that zone.
While we can never know what will happen next with 100% certainty, we can lean on the probabilities and consider them as price action continues. The secret, if there was one, is to understand the mechanics of price and what structures mean as well as where we can find potential order flow.
Most of all, understanding what a failure looks like – what most traders ignore – and being ready to capitalize on it.