Advantages and disadvantages of pullback patterns
Posted by professor at January 7th, 2014
Pullback patterns are used in many stock trading strategies however they are widely contested by traders. Some traders swear by them as the only means of trading from the chart, whilst others believe them to be nothing more than random, subjective diagrams.
It is true that subjectivity can be a problem for traders looking for pullbacks (as it can for any technical analysis) however, some traders are able to refine their pullback strategies to good effect.
One of the biggest advantages of using pullback patterns is that unlike some other technical indicators, for example moving averages or the RSI, pullback patterns can be discovered in real-time.
The benefits of this are huge, since a trader does not need to wait for any confirmation of price movement in order to make a trade. Rather, identifying pullback patterns allow a trader to predict the market in advance and thus not waste any time in initiating a new position.
Another advantage to a trader who is successful at identifying pullback patterns is that he or she is therefore able to come up with a strategy that is unique and unlikely to have been copied by any other trader. A trader who uses a moving average crossover strategy for example, may see his trades being repeated by hundreds of other traders since they are both receiving the same signal. However, by identifying pullback patterns by yourself, you can find patterns that other traders have missed and set your profit targets and stop loss points according to these patterns.
Of course, subjectivity is the main problem when using pullback patterns, since one man’s double top or reversal can look like another man’s head and shoulders or wedge. The reason why this is a problem is that it can become difficult for a trader to be certain just which pattern is occurring and therefore which direction in which to place a trade. Furthermore, such patterns are likely to look completely different depending upon the time frame being viewed. It is therefore essential for a trader to make sure he has rules and guidelines in place for identifying pullbacks, perhaps with confirmation rules from other time frames.
Change in trend
Another big problem with pullback patterns is that they too often occur just when the market trend is changing in direction. Since the pullback is designed to join the prevailing trend, it is all too easy to miss big parts of the action and only join the market when it is too late. A strong trend, for example, often has very few pullbacks, so a trader trying to enter the market will often find themselves frustrated at not being able to find a point to enter. And once the market does pullback, it may signal the end of that very trend.
Too many trades
Finally, pullback patterns can lead to some inexperienced traders in placing too many trades. Unless you have strong rules in place, it can be tempting to find several patterns in the market, in different time frames, thereby justifying countless numbers of different trades. It is therefore imperative to decide on the trading rules first and test them thoroughly before using the strategy in the market.