Trading Pullbacks

Simple Intraday Strategy Using Two Moving Averages

In this article I'm going to show you a very simple strategy for day trading stocks and ETFs (or any other market) using price pullbacks, two moving averages and a 5 minute chart. This will be about as basic as price indicator trading gets. Although basic, as long as you apply low risk stop placement, correct position sizing, and learn to stay out of the chop (price whipsaws), you can do well day trading using moving averages.

Alright, so maybe you're not comfortable trading breakouts like I've done through the years. Some traders just can't stomach getting into a new trade unless it's at what they perceive to be a discounted price to the stock's recent trading range. Buying new highs on a breakout absolutely petrifies some folks.

And that's fine. I recognize that my breakout day trading strategies and the strategies in my ebook aren't for everyone. That's what makes a market.

BUYING ON WEAKNESS AND SHORTING ON STRENGTH

The basic idea here for trading pullbacks is that once price has exhibited an impulse move as indicated by a cross of the moving averages, to wait for price to pullback and then trigger a trade once price resumes it's move in the direction of the original impulse wave. With pullback trading as opposed to breakout trading, you're looking to buy on weakness after a recent strong move up or short on strength after a recent strong move down.

After a move up, you want to see sellers push price down lower until price shows you it's ready to resume it's march higher. You will use a cross of the moving averages to determine the direction of the impulse wave and the faster moving average to determine when price has pulled back far enough to give a trade set-up. Then all you'll have to do is wait for a trade to be triggered using a buy-stop order.

I'm not going to get into using Fibonacci retracement strateges in this article, but I'd like to point out that many traders use fib retracements between 38% to 62% when initiating a pullback trade as basically a filter for whether or not price has pulled back enough to "get in", but all too frequently you will see price make a strong impulse move, only make a very shallow pullback, not even to a fib 38% line, and then continue with strength along it's trend. This method will get you into many trades whether price retraces to 38% or not.

If you don't understand what I'm referring to here, don't worry, it's not important for this simple method.

COMPONENTS

5 Minute Chart

Simple Moving Average (8 sma)

Simple Moving Average (25 sma)

TRADING PULLBACKS STRATEGY SIGNALS

Buy Setup: 8 sma crosses above 25 sma and price makes a new high (for the high: how many bars back is optional). Price pulls back to below the 8 sma. Filter: Price must not go below the last price pivot low.

Buy Trigger: Price moves above high of previous 5 minute bar.

Exit: Various exit strategies are possible here, including a bar close below the 8 sma OR a break below the last bar's low. Also a price target could be used at a Fibonacci extension level.


Short Setup: 8 sma crosses below 25 sma and price makes a new low (for the low: how many bars back is optional). Price pulls back to above the 8 sma. Filter: Price must not go above the last price pivot high.

Short Trigger: Price moves below low of previous 5 minute bar.

Exit: Same exit options, just reversed.



Notes:

  • Requiring a higher amount of bars on the lookback for a new high or low can help keep you out of the chop. The trade off is your amount of trades will be reduced.

  • Another option for trading pullbacks with moving averages is to simply initiate a trade once price retraces above (short trades) or below (long trades) the 8 sma. Some, however, will find this level of discretion far too much to handle. Requiring a set-up -- and then a trigger (break of previous bar) gives the trader, especially a new trader, two reference points where to get in -- and where to get out. Trading with too much discretion, imo, is a plan for disaster.

Lets take a look at a couple of examples of trading pullbacks on the etf QQQ using a 5 minute chart.

EXAMPLE 1

Chart example of trading pullbacks


EXAMPLE 2

Trading pullback strategy on chart using two moving averages

The key to trading pullbacks with moving averages is the same as any other price-indicator, day trading technique that relies on hopping aboard an existing trend. You have to become a master at identifying when the trend is coming to an end and price is possibly transitioning into sideways movement.

Learn to do this and two moving averages, along with the determination to stay with a trend might be all you'll ever need to be a pullback trader. Meanwhile, others like me will stick to volatilty compression and breakout techniques.