When to Doubt a Pullback

I find the "grey areas" on a chart fascinating; the areas where our bias or premise start to show signs of breaking down and our decisions are clouded by the uncertainty that prevails at the hard right edge of our screen.

This is where real learning happens! Where your knowledge, skills and attitude are pushed just beyond their limits.

Let's look at how this pullback played out (identified below as swing DE) and explore some of my thoughts as the pullback extended much deeper than I would expect (assuming my premise was still intact)…

The YTC Price Action Trader provides a process which I use to analyse price as it changes bar-by-bar (Volume 2, Sections 3.5 and 3.6).

However the above chart gives some insight into how I think on a scale above the bar-by-bar level.

My expectations are generally for continuation of the prior type of price movement. If the prior pullbacks within this trend were short and sharp, then I'd expect this pullback to be the same. If the prior pullbacks were long and extended, then I'd expect the same.

So in this case, I'd be looking for a pullback of about the same percentage depth as the prior pullback BC. The fact that DE extended beyond that prior depth indicates that something has changed. The market is no longer acting in the bearish manner expected of a trend with strong extensions AB and CD.

When a pullback acts in a manner which raises doubt as to the trend's ability to continue, I won't be too quick to abandon that trend. But I won't be taking the first pullback entry signal. The extended pullback will have given counter-trend traders some hope, so they're likely to act with orderflow that opposes my trade. I want to see a better entry, that comes from a second push higher which ideally traps and rapidly reverses on the counter-trend traders. This second chance entry would be a great entry short.

Unfortunately in this case it didn't provide a confident trap either. Price was not acting as it should if the premise for a continuation of the downtrend were still valid.

Certainly an entry short on the break of the lows of candle 3 or 4 would have provided sufficient opportunity to scratch for either breakeven or a small loss. But the best bet was to stand aside.

When price does not do what I anticipate, I won't immediately abandon my premise. But I will demand stronger proof that I'm right (and preferably proof that traps and stops out those who opposed my premise). If that stronger proof does not appear, it's time to get away from the chart for a few seconds (at least) and come back with a fresh mind. You'll need to reassess what is happening on your charts.

Happy trading,

Lance Beggs

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