How to develop pullback method - Weekend Reading

This is a never ending debate and a subject which is constantly argued about by traders and everyday I get emails from members asking how can  they buy pullbacks before the breakout. There is almost an obsession for some people, they want to be in stock before breakout.

Ed Seykota was asked this question in a seminar and his reply was (I am paraphrasing his words)

"Traders who  buy on pullbacks may miss some major movers that don't pullback and are sure to be in  all the moves  that fail to follow through. Buying pullback ensures you will be in most reversal moves."

In the stock market you can buy breakouts and make money. You can also make money buying pullbacks. There are hundreds of breakout based methods in public domain on both side.  If you are interested in buying pullbacks then look at the RSI2 method which I have shared before. It buys pullbacks. 

As a general observation after studying the markets for last 12 years or so and especially studying stocks which go up 100% plus in a year or 25% plus in a month, I can tell you that if you are primarily a pullback trader you will miss out on some of the best opportunities in the market.

But because market is so vast and you have 10000 stocks to play with there are also enough pullback opportunities. It is not very difficult to develop pullback methods. The most commonly used approach to developing pullback methods are:

1. Buy first pullback after a major breakout. You can define major breakout in many ways like say a multi month  trend line , or breakout above channel, or breakout above 200 day moving average or a breakout of 25% or more from a 52 week low, or any such major milestone.
2. Buy first pullback to 50 day moving average. This is like most commonly used swing trading method. Some time back I studied the most popular swing trading courses and most rehash this same concept again and again. Same soda different bottle and different color. 50 ma becomes 20 MA or 39 MA or some other MA.
3. Buy double bottom at top of the range on trending stock. Again this is extremely popular method. You find a trending stock on longer time frame that has in recent days gone in to range. You buy a double bottom pattern in that range. These kind of methods work well on high float stocks and stocks with high liquidity. Especially well on stocks in S&P 500 and Nasdaq 100. The Curtis Faith setup which I shared  sometime back is a good example of that kind of setup. IBD also talks about this setup as one of the bases to look for in leading stocks. Typically you should not try and trade these kind of setups on small cap stock. In most small caps there is one big rally and then they exhaust themselves. Buying such pullbacks on most of them would make you a bag holder. Such setups work well on established stocks where there is lot of fund support. The funds like buying dips so the setup works. For small cap most of the time it is one rally and end of story. 
4. Retracements to Fib levels is another very popular pullback buy techniques and if you just run a search you will find over 1000 such swing trading setups. 
5. Retracements to 10 or 20 day lows. This is another very popular method for buying pullbacks and again tends to work on bigger stocks.
6. Retracement to ATR channel is another commonly used pullback method. 
7. Oscillator based pullbacks. There is a vast array of oscillator based methods. Most traders have some sort of oscillator like Stochastics on their charts and such pullback methods are very popular. If you go to the Wealthlab archives you will see examples after examples of pullback based systems that have performed well in backtesting.

The key to trading pullback again boils down to selecting the right kind of stocks to trade pullbacks on. Some stocks like momentum stocks or growth stocks are best traded using breakout methods. Because they are very prone to sudden burst of momentum phases which can go vertical without any pullbacks. 

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