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Lesson 05 · Trend following

Pullback Trading Strategy: Buying Dips in an Uptrend

  • 12 short cards
  • About 5 min to read
  • 5 quiz levels · 30 questions
  • Beginner

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See it on a chart

5055606570
  • Price (candles)
  • 20-period EMA
  • 50-period EMA

An uptrend with three pullbacks. Each dip pauses near the 20-period EMA (gold) before the trend carries on. Prices are made up for illustration.

What is a pullback?

Trends rarely move in a straight line. In an uptrend, price rises in bursts, then dips back a little before the next rise. That dip is a pullback, also called a retracement.

Pullback traders wait for the dip, then buy when price shows signs of turning back up.

A pullback trade in four steps

  1. A riseThe uptrend makes a new high
  2. A dipPrice falls back a little: the pullback
  3. A turnBuyers return. You buy here
  4. The next riseYour stop sits just below the dip

First, check there really is an uptrend

Use clear rules. Price should be making higher highs and higher lows1. As an extra check, the 20-period EMA should be above the 50-period EMA, with both sloping up.

If you can’t tell whether there is a trend, treat it as no trend and don’t trade.

Is there really an uptrend?

Yes: look for a pullback

  • Higher highs and higher lows
  • 20 EMA above the 50 EMA
  • Both averages sloping up

No, or not sure: don’t trade

  • A lower low has appeared
  • The averages are flat or tangled
  • You can’t tell which way it’s going

Where pullbacks tend to stop

Common places are: the 20 or 50 EMA; an old resistance level that has become support, as you saw in Lesson 35; and the Fibonacci retracement levels.

Fibonacci retracements measure how much of the last rise has been given back. The common levels are 23.6%, 38.2%, 50% and 61.8%2. The 50% level isn’t actually a Fibonacci number. It comes from the old idea that markets often give back about half of a move2.

None of these levels is magic. They matter partly because many traders watch them. When several line up at the same price, it is called confluence, and the area becomes more important.

Fibonacci levels for a rise from £50 to £70

LevelHow much is given backPrice
23.6%£20 × 0.236 = £4.72£65.28
38.2%£20 × 0.382 = £7.64£62.36
50%£20 × 0.5 = £10£60.00
61.8%£20 × 0.618 = £12.36£57.64

The rise is £70 − £50 = £20. Each level = the high (£70) minus that share of the rise. A dip past 61.8% is often too deep for these rules.

Wait for a signal before buying

Price touching a support area doesn’t mean the dip is over. It might keep falling. Wait for a sign that buyers are coming back.

Two common candle signals3: a hammer, a candle with a small body near the top and a long lower wick, showing sellers pushed price down but buyers pushed it back up; and a bullish engulfing candle, a green candle whose body completely covers the previous red candle’s body4.

Another simple signal is price breaking above the previous candle’s high. The trade is wrong if price closes below the low of the dip, or the uptrend breaks with a lower low.

98100102104HammerEngulfing
  • Price (candles)

Two buy signals. The hammer has a small body near the top and a long lower wick: sellers pushed price down, buyers pushed it back. The bullish engulfing candle’s green body covers the whole of the red body before it.

Pullback trading rules

Entry

  • Check the uptrend: higher highs and higher lows, with the 20 EMA above a rising 50 EMA.
  • Wait for price to dip into the 20–50 EMA area or an old resistance level.
  • Buy after a hammer or bullish engulfing candle, or when price breaks the previous candle’s high.

Exit

  • First target: the last swing high.
  • Trail a stop under each new higher low for the rest of the trade.
  • Get out if the uptrend breaks with a lower low.

Risk

  • Stop a little below the low of the dip.
  • Aim for at least 2-to-1 reward-to-risk to the last high.
  • Skip dips that give back more than about 61.8% of the last rise, or close well below the 50 EMA.

Worked example: buying a pullback in a share

  1. A share is in an uptrend: swing highs at £58 then £64, swing lows at £52 then £57.
  2. It rises to £68, then dips to £62.40, where the 20 EMA meets an old resistance level at £62.
  3. A bullish engulfing candle closes at £63.20. You buy at £63.20.
  4. Your stop goes at £61.80, just below the dip’s low with a little extra room: £1.40 of risk per share.
  5. Your first target is the last high, £68: a gain of £4.80, about 3.4R. You trail a stop for the rest.

Pros and cons of trading pullbacks

Strengths

  • Better buying price than chasing a new high.
  • A close, logical stop just below the dip.
  • Trades in the same direction as the trend.

Weaknesses

  • Some dips turn into full reversals.
  • In very strong trends price may never dip enough, so you miss the move.
  • Needs clear rules, or you start seeing trends that aren’t there.

Key terms

Pullback (retracement)
A short move against the main trend before it carries on.
Fibonacci retracement
Levels at 23.6%, 38.2%, 50% and 61.8% of the last move, used to judge how deep a dip is.
Confluence
Several support signals at the same price.
Hammer
A candle with a small body near its top and a long lower wick.
Bullish engulfing
A green candle whose body completely covers the previous red candle’s body.

Sources

Numbers in the lesson, like 1, point to these sources.

  1. Dow Theory. StockCharts ChartSchool.
  2. Fibonacci Retracements. StockCharts ChartSchool.
  3. Candlestick Bullish Reversal Patterns. StockCharts ChartSchool.
  4. Nison, S. (1991), Japanese Candlestick Charting Techniques. Book.
  5. Murphy, J. J. (1999), Technical Analysis of the Financial Markets. Book (New York Institute of Finance).

Lesson complete

You have reached the end of the lesson. Now test what you learned with the five-level quiz.

Start the quiz

Quiz zone

Test yourself: Trend Pullback quiz

Five levels, from the basics to expert judgment. Clear each level to unlock the next.

  1. Level 1: Foundations. Recognise the strategy and its vocabulary.
  2. Level 2: Mechanics. Know how the signals and rules work, and why.
  3. Level 3: Application. Apply the rules to realistic chart situations.
  4. Level 4: Numbers & risk. Size, measure and manage the trade with real calculations.
  5. Level 5: Mastery. Judge edge cases, failure modes and market conditions.

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See all 30 questions in this quiz

The questions only. Answers and explanations appear when you take the quiz above.

Level 1: Know what a pullback is

  1. What is a pullback?

    • The end of a trend
    • A short move against the main trend before it carries on
    • A crossover of two averages
    • A sudden jump at the open

  2. How do you spot an uptrend?

    • Higher highs and higher lows
    • Lower highs and lower lows
    • One big green candle
    • The same high and low again and again

  3. True or false: pullback traders buy while price is dipping in an uptrend, rather than at new highs.

    True or false?

  4. Where does the stop usually go on a pullback trade?

    • At your entry price
    • There’s no need for a stop
    • A little below the low of the dip
    • Above the last high

Level 2: Understand entries and trend breaks

  1. Why wait for a signal candle instead of buying as soon as price touches the 20 EMA?

    • You don’t need to wait
    • Signal candles are cheaper
    • A touch doesn’t mean the dip is over. A signal shows buyers coming back
    • The 20 EMA is always wrong

  2. Which of these retracement levels is not actually a Fibonacci number?

    • 38.2%
    • 23.6%
    • 50%
    • 61.8%

  3. True or false: several support signals at the same price is called confluence, and it usually makes that area more important.

    True or false?

  4. Which of these most clearly tells you an uptrend has broken?

    • Price makes a lower low, below the last higher low
    • A small red candle
    • Volume is a bit lower than usual
    • Price dips to the 20 EMA

  5. You look at a chart and can’t tell whether there’s an uptrend. What should you do?

    • Sell short
    • Use a bigger size to make it worth it
    • Treat it as no trend and don’t trade
    • Buy anyway in case it is

Level 3: Read real setups

  1. Swing highs: £40, £44, £49. Swing lows: £37, £41, £45. Price is now £46 after falling from £49. The 20 EMA is at £45.80. What fits the rules?

    • Watch for a buy signal around £45 to £46 before buying
    • Buy straight away at £46
    • Wait for a new high above £49 and buy then
    • Sell short, the trend is over

  2. Same chart, but price closes at £43.50, below the £45 swing low. What now?

    • The uptrend has broken with a lower low, so no buy
    • Buy half now and half later
    • Buy: it’s even cheaper
    • Move your planned stop lower

  3. Which candle best shows buyers stepping in at support?

    • A tiny candle with no wicks
    • A big red candle closing at its low
    • A candle that gaps down
    • A bullish engulfing candle

  4. The daily chart is in an uptrend, but the weekly chart has just made a lower low. How should that affect a daily pullback trade?

    • Buy twice as much
    • Be more careful: use a smaller size or skip it, because the longer chart disagrees
    • Ignore the weekly chart
    • Only trade the weekly chart from now on

  5. A candle has a small body near its top and a long lower wick. What is it called?

    • A death cross
    • A bullish engulfing candle
    • A gap
    • A hammer

  6. You bought a pullback. Where is your first target?

    • Twice the last swing high
    • The last swing high
    • The low of the dip
    • There isn’t one

Level 4: Measure reward, dips and size

  1. You buy at £63.20 with a stop at £61.80. How much are you risking on each share, in pounds?

    Type a number (a share).

  2. Entry £63.20, stop £61.80, target £68.00. What is the reward-to-risk? Give two decimal places.

    Type a number (to 1).

  3. A rise went from a swing low of £50 to a swing high of £70. What price is the 50% retracement?

    Type a number.

  4. Same rise, from £50 to £70. What price is the 61.8% retracement?

    Type a number.

  5. Same rise, from £50 to £70. What price is the 38.2% retracement?

    Type a number.

  6. Your account is £10,000 and you risk 0.75%. You buy at £63.20 with a stop at £61.80. How many shares so that hitting your stop loses only 0.75%? Round down.

    Type a number (shares).

  7. You hold 50 shares bought at £63.20. Price reaches your first target of £68 and you sell. What is your profit before costs, in pounds?

    Type a number (profit).

Level 5: Tell pullbacks from reversals

  1. Price gives back 85% of the last rise and cuts straight through the 50 EMA. What’s the best reading?

    • A normal pullback
    • A great bargain: buy more than usual
    • A golden cross
    • A dip that deep often means the trend is turning, so stand aside

  2. In a very strong trend, price stays well above your 20 EMA and never dips to it. What do strict pullback rules cost you?

    • You may miss the move, but you avoid buying at stretched prices
    • They make you go short
    • They force you to buy the high
    • Nothing: you’ll catch it anyway

  3. Your stop is just below an obvious swing low where lots of traders put stops. What’s the risk, and a common fix?

    • Use no stop
    • Price can dip briefly to hit those stops. Give yourself extra room, such as part of an ATR below the low
    • Put the stop exactly on the low
    • No risk: obvious levels always hold

  4. Testing shows pullback trades win 55% of the time with 2R targets. Buying new highs wins 40% of the time with 2R targets. Costs are the same. Which has the higher expectancy?

    • You can’t tell
    • Pullbacks: +0.65R against +0.20R
    • They’re the same
    • New highs: +0.80R against +0.55R

  5. Why do support levels like the 20 EMA or the 61.8% level matter at all?

    • They predict the future
    • Partly because many traders watch them and act there
    • Brokers set them
    • They’re magic numbers that always work

  6. Your pullback trade reached the first target. How do these rules manage the rest of the trade?

    • Move the stop down to give it room
    • Sell everything and never trade that share again
    • Trail a stop under each new higher low
    • Remove the stop

  7. A setup gives a reward-to-risk of only 1.2-to-1 to the last high. What do the rules say?

    • Take it: any pullback is good
    • Take it at double size
    • Skip it: aim for at least 2-to-1
    • Take it and move the target higher

  8. Why does a pullback give a clearer stop than buying at a new high?

    • Pullbacks always win
    • The low of the dip gives an obvious place where the idea is wrong
    • New highs never have stops
    • The stop can be further away

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