A pullback is not just a pullback. There are different kinds of pullbacks. They can all be classified into channels – expanding, condensing, symmetrical, their angle either against the trend or with the trend. Inside those channels, we get different opportunities to re-enter in the direction of the trend.
We can play breakouts, bounces from the lower boundaries of those channels (in case of an uptrend), or bounces from the upper boundaries (in case of a downtrend).
A channel can be drawn as soon as we get 3 points, or to be more precise, two highs and a low, or two lows and a high. We then connect the two dots on one side (1+3), and copy it so it connects with the dot on the opposing side (2).
Of course, whether the hypothetical point (4) connects or not, is up to price. More often than not we do not get a symmetrical channel, which would be classified as a flag, but rather an expanding or condensing channel, like in this case. We then correct our channel line.
In that fashion, we can categorize every pullback into three categories.
- Symmetrical/parallel channels
- Condensing channels
- Expanding channels
Then, these can be broken down again into price chart patterns. There are tons of continuation price chart patterns out there, but the following include basically all of them.
- Flags (symmetrical channels)
- Symmetrical and flat top/bottom triangles (condensing channels)
- Broadening wedges (expanding channels)
And that’s mostly it. Also, we can always paint channel structures inside channel structures, as price charts are fractal.
And of course, inside those channels and continuation patterns, we can find traditional price action patterns like double and triple tops/bottoms or fakeouts.
Also, sometimes, but not often, a channel flows directly into another channel. That is, for example, the case with Head & Shoulders. But price can also transgress from a steep channel into a steeper channel, for example, there does not necessarily have to be a change of direction involved.
So if we can find the macro channel in which price is moving at the moment (zoom out!), either by simply looking at the structure of highs and lows, or by drawing the channel barriers, then it is really easy to know in which direction is price headed – in the direction of the angle of the channel, of course.
And if we can then find a trend inside that channel that goes with the angle of the channel, and then inside that trend we are presented with a consolidation (=pullback) that presents us with an opportunity to hop on to that trend with a defined stop loss, wouldn’t that sound too good to be true?
Take a look at the picture above. We broke out of a long consolidation, finally dictating where price could go. I then painted two possible channels in yellow and magenta and a flag in green. Do you think you could find a great trade somewhere in that channel with a sufficient Reward:Risk Ratio? I certainly do hope so.
I don’t draw these channels anymore on my chart, I can see with my bare eyes where price is headed. I do mark highs & lows, because that shows me sufficient information about price direction. But this is how I started training my eyes. By drawing channels literally everywhere. If you can find the macro channel, and then the trend within that macro channel, AND THEN a continuation pattern within that trend, you are set for life. That is what I do every day, all day long.
Also, do pay attention to the steepness of a channel: how reliable are channels with a 15-20° angle opposed to channels with a 45° angle or even higher? Make your observations and let me know. Maybe think about what happens when steep trendlines break versus when flatter trendlines break. Which of those two insinuate a trend change, which of those two fake out more often?
And how do we trade downwards or upwards moving channels versus horizontal channels? Are expanding channels tradable by us as trend traders, or do we stay away from them? What about condensing channels? What is the difference between taking a trade from a lower channel barrier as opposed to taking a trade in the middle of a channel? Observe, make up your mind. Okay, one more.
Here, we have been in an obvious downtrend for hours already, in a tight and steep channel. Then the Asian session came around and we started to make a somewhat flatter channel including a condensing triangle pullback (in magenta). Again, we connected point 1 and 3 and copied that line up to point 2. Then we get a reaction at projected point 4, with the trend, and a break out of our continuation pattern. Alas, we got a triple-A trade.
Can you sit in front of your monitor 8 hours every day, watching 8-12 instruments, and take only 1 or 2 trades during that time that are similar to this one, and then let it run? If yes, congratulations, you have just become a profitable trader.
By the way, the chart setup I am presenting here is a sneak peek of my good old Futures strategy adopted to Forex and other markets. Nothing has changed, we are still trading pullbacks within the trend, we merely switched from tickcharts to timecharts and stayed true to our principles. Expect more to come soon, I am stoked to bring this to all of you! It’s a lot of fun trading like that. As always, questions below! Fire away.