Before getting into the specifics of the buy setup, let us reiterate the importance of trends over the importance of specific patterns. Patterns can be a challenge to find and figure out and sometimes, we can become fixated on some of the details of pattern analysis. This is why we must always remind ourselves that trend direction is more important than the individual patterns. Patterns are gateways that provide safe (low risk) entries into a trend or an indication that a trend might be coming to an end and a reversal pattern is presenting itself. This being much harder to find, figure out, and identify.
The Pullback – Buy Setup
The first criteria of the buy setup you’ll need is an uptrend. Look for at least two higher highs and higher lows. Your moving averages should be sloping up.
Next, you’ll need at least three down bars. As far as the individual bars go, lower highs are more important than lower lows. It is better if the bars are near the moving averages. It is also better if there is a reversal bar at the end of the three pullback bars. It is not necessary but good if the reversal bar has a pick-up in volume.
Every trade should have an entry stop and a target to define the trade from a risk/reward perspective. Also, have a trade management set of rules to manage how you exit the trade.
The entry will be above the prior bars high. Generally, the entry bar will be after the three bar pullback and after the first green reversal bar. This will put the entry above the green reversal bars high. If there is not a green reversal bar, the entry will be above the high of the last red bar of the pullback as shown in the example above.
What is a discretionary entry?
On every trade you can take, the trade is based on the prevailing time frame (i.e. the 5 minute time frame). Another option would be to drill down one major time frame to the 1 minute time frame if you are primarily using a 5 minute chart for your trading. This entry would be your discretionary entry.
The most important takeaway is to always have an exit plan when you take a trade. Since a buy setup is a trending opportunity, you’ll want to go with a trade management rule that will somehow take advantage of the trend if the trade continues. One of the keys to proper training is to cut your losses short and let your profits run.
Written by Michael DiGioia, Director of Education
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