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Pullback

Updated on May 8, 2024
Article byNupur Chowdhury
Reviewed byDheeraj Vaidya, CFA, FRM

Pullback Meaning

A pullback occurs when the price of a stock or commodity pauses or goes against a prevailing trend in the stock market. It is a temporary dip in a generally upward trending asset price. Unlike ‘reversal,’ in which there are more permanent price drops, a pullback remains only for a short while.

Pullback traders try to buy a stock or commodity when the price has dipped temporarily amidst a broader, upward trend. To trade, the market must be trending in a particular direction, upwards or downwards. Without a trend within to trade, it is impossible to profit from a pullback.

Pullback Meaning

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Key Takeaways

  • When a stock or commodity moves, temporarily, in the opposite direction of an ongoing trend, it is known as a pullback.
  • Pullback trading involves buying an asset at a lower price point, only to sell it when the upward trend reasserts itself in the future.
  • The two main pullback trading strategies include the aggressive versus the conservative approach.
  • One of the most important steps in pullback trading is accurately gauging whether a pullback or a trend reversal causes a dip in asset prices.

How Does Pullback Trading Work?

Pullbacks can happen due to many reasons. Most stocks with an average history of upward trends face a drop in their prices due to prevailing brand and market sentiments. If a scam or hidden insolvencyInsolvencyInsolvency is when the company fails to fulfill its financial obligations like debt repayment or inability to pay off the current liabilities. Such financial distress usually occurs when the entity runs into a loss or cannot generate sufficient cash flow.read more is brought into the public light or news of continuous revenue loss, many investors start selling off the shares of such a brand. Consequently, it leads to a fall in the share prices of the brand. Such things are common in the commodity marketCommodity MarketThe commodity market is a place where people buy and sell positions in commodities such as oil, gold, copper, silver, barley, wheat, and so on. Started with agricultural commodities, there are now fifty main commodity markets throughout the world, dealing with over a hundred commodities.read more, too, especially in the case of gold and oil prices.

The temporary dip in a generally upward trending asset price is a stock market pullback. Notice that the dip should be temporary, and if it continues to dip lower without making a recovery, it will become a reversal.

A pullback comes in handy to achieve the fundamental trading aim of buying low and selling high. To successfully trade pullbacks, you need to buy the stock or commodity during the ‘dip’ and then sell it during the ‘rally.’ Psychologically. Therefore, a pullback trading strategy is easy to create and execute, even for beginners.

Pullbacks, therefore, offer traders buying opportunities for security that keep rising in value. For example, for a trader who cannot afford to purchase the stock of Amazon or Apple as they are perennially rising in price, pullback trading may seem like a lucrative opportunity to make a purchase depending on the price drop.

This Reuters report discusses how global equity markets faced a pullback earlier in 2021 after a record high trend as investors sold shares of tech companies. The report also shows the movement of 10-year Treasury yields that faced pullbacks in the face of Covid-19.

Chart

 Let us look at the General Electric Company Chart below to understand the pullbacks.

Source

The highlighted portions in the above chart represent the pullbacks. Simply put, they show a temporary reversal in stock price or correction against the trend prevailing in the equity market. Here, we can observe that the stock price retraced or pulled back from an upward trend prior to continuing in the downtrend. In this case, traders can identify such pullbacks and wait for the confirmation of a reversal using different chart patterns and indicators.

Once the confirmation materializes, they can enter trades in the downtrend’s direction to make significant gains. In the case of downtrends like these, traders may consider short selling to benefit from the downside move.  

If traders want to observe more such charts demonstrating pullbacks, they can find them on TradingView.

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Example

One fine example of a pullback can be observed in the context of the pandemic. After losing their jobs due to the globe-sweeping COVID-19, many young Americans decided to use a part of their stimulus checks to make an income through the stock market. The sports-betting company known as DraftKings presented an excellent opportunity for pullback trading when its stocks started rising in early February of 2021, after consolidating for the preceding two months. The ARK Next Generation Internet ETF added DraftKings to its holdings, and this news sparked the rally that began on February 2. Traders who’d purchased DraftKings stock during the two-month consolidation period could sell at a high of about $56, taking advantage of one of the most lucrative pullback trading opportunities in recent months.

Internet-based travel and hotel booking company, Trivago, went through a similar cycle of pullback and surge during the pandemic. With the travel and tourism sector badly hit in 2020, the company’s stocks took a temporary plunge.

However, as more and more vaccines became available, Trivago stocks began seeing upward momentum again. With the company on its quest back to normalcy, savvy investors have started monitoring Trivago shares for trading opportunities shortly.

Pullback in Forex

Forex traders make money by trading in global currencies. The foreign exchange rate for every currency is determined in the Forex market. A particular currency’s price (or exchange rate) could be ascending or descending. Forex is one of the most actively traded markets in the world. Hence, pullbacks occur regularly in the forex market. Still, the occasional forex pullback is inevitable as investors rush to cash in their profits from time to time.

Forex traders regularly use pullbacks to enter market positions at the best possible price levels. For example, a trader could use this strategy to trade a currency pair at the lowest possible price pointPrice PointA price point (PP) is a selling price that a manufacturer or retailer recommends for its product or service to remain competitive in the market while also making a profit.read more during an uptrend. However, to successfully execute such trades, one needs to know how to spot a pullback. After all, how can someone be sure that a sudden dip in a currency results from a temporary swing and not a reversal of the overall trend?

Spotting pullback in Forex

One of the easiest ways of spotting forex pullbacks is to keep an eye out for trendlines. When the price of a currency hits the same line on a chart thrice in a row, it is known as a trendline. They are inevitable in forex trendlines.

What is a trendline

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If the price keeps pulling back to the same line on a chart more than twice, one has a trendline. And they can use these dips to enter the market, knowing that prices will rise again.

The only drawback of this trading method is the risk of missing the dip. In other words, a beginner or an impulse trader may sell the stock before it can swing back up again. In such cases, they run the risk of losing money.

There are two major strategies you can use for this kind of trading: the aggressive and the conservative approach. The aggressive approach involves entering a trade when the price returns to the pullback area. This point usually marks the end of the correction wave. Hence this strategy will provide the highest reward/risk ratio. It allows a trader to enter the market at the best possible price.

On the other hand, the conservative approach involves entering the market when the stock or commodity price has continued the trend and broken into a new low. The conservative trader goes with the momentum of the market. As a result, this strategy’s potential risk/reward ratio is smaller.

Pullback vs Reversal

At first glance, both might look similar on a chart. However, there is a major difference between the two. A reversal represents a shift in the overall trend of an asset price. So if the price of the stock were trending upwards before, a reversal would mean a new downward trend. A pullback, as mentioned above, is simply a temporary counter-move within a larger trend. Therefore, they are short-lived, while reversals are more long-term.

The goal of every trader is to identify pullbacks for better entry points. But they also have to avoid getting caught in trend reversals. Context and price action are the two main factors that can help one differentiate between a reversal and a pullback. To understand price movement, a trader must determine whether the current asset prices represent the trend’s beginning, middle, or end.

One needs to take a big-picture view of the market, understanding what caused a trend to start and where it is headed. It will help one predict major shifts in the market that might cause an ongoing trend to change direction.

By paying attention to price action, traders will gauge whether a dip in the asset price is a pullback or a reversal. For example, if there is a downturn in a stock that is trending upwards, they should wait to see whether the momentum turns back in their favor. On the other hand, if the downturn is steady and uninterrupted, it may signal a reversal rather than a temporary dip.

Frequently Asked Questions (FAQs)

What does pullback mean in stocks?
A stock market pullback refers to a brief decline in the market price after a steady ongoing trend. It offers the traders buying opportunities in the stock market. Pullback trading allows the traders to buy an asset when the price is low and sell it when the trend comes back to its former upward movement.

Why do pullbacks happen?

The pullback can occur thanks to changes in market sentiments for various reasons. A scam or hidden insolvency suddenly brought to light can be one of those reasons. Sudden change in the price of metals such as gold can influence their share value. A change in base currency can be the pullback in forex.

How do we identify pullbacks and reversals?

A pullback is a temporary movement against an upward trend in market prices. If the security makes pullbacks but continues on the downward track for an extended period, it is reversed.

This has been a guide to Pullback and its meaning. Here we discuss how pullback trading works along with examples in forex and its differences from a reversal. You can learn more from the following articles –