Breakout and Pullback Risk/Reward

[pavilion103]

I have spent a lot of my time recently learning about breakouts. One problem I have had is not enough high multiple R wins. I realise this can be due to poor entry/too tight stop etc.

I have a question about pullbacks. I haven't studied them in great detail but it would appear that they seem to offer greater reward/risk. It allows me to place my stop tighter and achieve larger multiple of R wins (but obviously a higher number of losses too). Is this generally the case?

Depending on the breakout, I have waited to see if some will pullback and either enter on a low volume pullback or set a new buy entry a tick or two above the high of the breakout bar (see below - I have entered (in my simulator) on the second last bar, the one that broke the green line).




I am looking to trade both breakouts and pullbacks.

 

[Boggo]

Re: Beakout and Pullback Risk/Reward

I have a question about pullbacks. I haven't studied them in great detail but it would appear that they seem to offer greater reward/risk. It allows me to place my stop tighter and achieve larger multiple of R wins (but obviously a higher number of losses too).

"Pullbacks" is an interesting term. I look for stocks that are on an uptrend, look at where that stock may be in its 'pattern cycle' and then wait for the correction (pullback ?) before entering.
There are levels where a stock may pullback to and this happens more often than most realise on stocks that are in a steady upward trend.
The stop loss point is clearly defined too in these situations.

Two current examples of what I mean below (the software I have used here does the calcs and provides a min target based on the previous pattern but you can do it without that when you know what you are looking for).

(click to expand)

 

[tech/a]

Re: Beakout and Pullback Risk/Reward

"Pullbacks" is an interesting term. I look for stocks that are on an uptrend, look at where that stock may be in its 'pattern cycle' and then wait for the correction (pullback ?) before entering.
There are levels where a stock may pullback to and this happens more often than most realise on stocks that are in a steady upward trend.
The stop loss point is clearly defined too in these situations.

Two current examples of what I mean below (the software I have used here does the calcs and provides a min target based on the previous pattern but you can do it without that when you know what you are looking for).

(click to expand)

Great topic you come up with some meaty stuff Pav.
The first real student in tech analysis Ive seen on here.

Firstly a couple of things again strapped for time.

(1) Expectancy should be the result of a great number of trades not an expectation of what youll gain if a trade stop placement and exit is executed as planned.
(2) The formula you use for Breakouts can easily be adapted for Pullbacks by turning it into an alert I'm sure I gave you the code.
(3) There are lots of ways to skew your R/R.
My stop is never set in stone---(On the Stop side) I will and often do RAISE IT to meet a falling price.(On the exit side) I will also add agressively to a trade during a run often day trading it and letting the original run with a trailing stop.

As you can see this is designed to minimise loss and maximise gain pro actively rather than set and forget passive trading. Only suited to discretionary trading.
I have set rules.

 

[sinner]

Bulkowski has a great section on pullbacks

http://thepatternsite.com/pullbacks.html

I like trading the first pullback in 9/30 type setups seen here

http://www.trading-naked.com/mb-9-30-setup.htm

but also, you can use this strategy in P&F charts and I have used that sometimes on the EURUSD 10tick/1box reversal p&f, I saw motorway once post a very simple trading rule system for 1 tick p&f charts from the 1920s or similar that waited for the pullback and then move in direction of trend which is when you enter the trend.

 

[pavilion103]

I know there are a lot of complicating factors but in general does trading a pullback allow a tighter stop?

Also, does the set up I traded in my sim (original post) look ok? Are these the types of set ups worth looking for?

 

[tech/a]

I know there are a lot of complicating factors but in general does trading a pullback allow a tighter stop?

Also, does the set up I traded in my sim (original post) look ok? Are these the types of set ups worth looking for?

Your ALK trade I certainly wouldn't call a pullback.
Generally the stop can be tighter but unless you wait long enough to know within reason that the "pullback" has stopped pulling back then you'll be stopped out more often than not.
They are complex structures which BOGGO alludes to.
Not just a simple wait for a bar to pause.

 

[pavilion103]

I did some further research and found this. A bit of a summary about Pullbacks.

It appears that these are some of the advantages:
- Offer potentially higher Risk:Reward ratio (as I suspsected)
- Offer a more obvious/logical stop loss point
- Confirmation of trend - it can be easy to misidentify a trend in a breakout (especially for beginner traders like myself)

Would be interested to see if anyone has any other points or disagrees with these.

Definition
Pullback occurs after a breakout of a certain psychological level, when price returns to the level it previous broke. If price bounces from that level, it is said that price 'pulled back' to the level. The psychological level can be a Support level, a Resistance or even a dynamic level (trendline).

The Pullback is a very strong trading signal, due to several reasons:

1.Confirmation of Trend - The breakout prior to the pullback confirms that price is in a strong trend, that is capable of breakout psychological levels. This empowers our trade and gives us extra-confirmation which, if we traded the breakout itself, we would not have. This way we trade pattern but give resepect to the prevailing trend - and combine swing trading with trend trading.

2.Logical Stop Loss - When trading pullback, we know exactly where to place the stop loss, contrary to the breakout in which we do not have a logical stop loss position. Our stop loss is also smaller when trading pullbacks. This improvement in stop loss can result in much higher risk:reward ratio, better profitability and smoother equity curve. Even the smallest decrease in your stop loss size can have an astounding effect on your balance.

3.Chart Pattern is Confirmed - If we trade the breakout itself, it is possible that the chart pattern was misidentified and is actually too weak to trade. However, if we wait and confirm a breakout, the chart pattern is confirmed beyond any doubt and we have a much reliable signal.

 

[pavilion103]

Your ALK trade I certainly wouldn't call a pullback.
Generally the stop can be tighter but unless you wait long enough to know within reason that the "pullback" has stopped pulling back then you'll be stopped out more often than not.
They are complex structures which BOGGO alludes to.
Not just a simple wait for a bar to pause.

Yeh I know, I am clutching at straws a bit with that one.
Do you think if is had come closer to the old resistance (potentially new support) level and stayed around there for 3-5 bars then that would constitute a pullback?

I'm not sure if there is a general rule/consensus/thoughts on what % retracement would constitute a pullback (e.g. 5% or something)?

 

[pavilion103]

I am seeking to gain clarification on the below illustration. It might not be the best example but I want to know if my theory here is in fact accurate.

In this example GUF breaks out of a trading band. The width of the band is 10 cents so I set the profit target 10 cents above the band (not that I would necessarily sell at this point). From this I can calculate my risk:reward ratio.



On the breakout (not that this is a good breakout)
Entry: $1.30
Stop: $1.20 (8.3%)
Target: $1.43
Reward:Risk 13:10 = 1.3:1

On the pullback (say if it pulled back after the break at around $1.25 for a few days)
Entry: $1.25
Stop: $1.20 (4.2% - maybe too tight?)
Target: $1.43
Reward:Risk 18:5 = 3.6:1


Summary:
Breakout = 1.3 R:R
Pullback = 3.6 R:R

I'm not sure what the experienced traders think of this. Like I said, probably not the best example but just one to put my thoughts to paper and see if what I was thinking in my head makes sense.

 

[sinner]

I'm not sure if there is a general rule/consensus/thoughts on what % retracement would constitute a pullback (e.g. 5% or something)?

You are looking at it the wrong way around IMHO.

Look for a swing low or price action reversal bar with the trend you are trying to follow. Draw support at the lows, then look to see how well that support lines up with previous near-term resistance.

In this case (NYSE:ORCL daily) I identified a breakout from an intermediate swing high and then wait for swing lows or price action reversal bars to form. These setups don't always work but they do always provide a clean picture of what is going on. A penetration of the 3 bar swing low indicates the breakout failed.

 

[Boggo]

3.Chart Pattern is Confirmed - If we trade the breakout itself, it is possible that the chart pattern was misidentified and is actually too weak to trade. However, if we wait and confirm a breakout, the chart pattern is confirmed beyond any doubt and we have a much reliable signal.

This is getting into a whole new area which I don't really want to as you are really on track with your approach pavilion.
I would like to point out a trap with breakouts that often happens.
I have referred to knowing where a stock is in its life cycle (so has tech/a) and below is an (average) example of where you can get caught out.
My breakout system scan picked this as a breakout recently (twice actually) but just an eyeball glance saw a potential pattern that had formed and an associated problem with upside potential.

tech/a might like to apply some VSA to that breakout area that may add to what was happening on both breakout attempts as there was higher volume on both bars.

(click to expand)

 

[pavilion103]

Having a look at some charts for breakouts and pullbacks I am so confused.

With breakouts, I don't know when to enter on the day/bar of breakout and when to wait for a confirming day/bar before entry.
Are there any "tricks" or things to look for?

 

[tech/a]

Having a look at some charts for breakouts and pullbacks I am so confused.

With breakouts, I don't know when to enter on the day/bar of breakout and when to wait for a confirming day/bar before entry.
Are there any "tricks" or things to look for?

What do YOU think are extenuating factors?
List them.
In other words you have found not all breakouts are equal.
So what factors in YOUR view make a better breakout to trade?

 

[pavilion103]

What do YOU think are extenuating factors?
List them.
In other words you have found not all breakouts are equal.
So what factors in YOUR view make a better breakout to trade?

Ok the things that come to mind for me are:
- the more times a stock touches the support/resistance level
- the longer those support resistance levels have been in play
- a breakout in the direction of the underlying trend
- breakout on high volume, wide spread bar
- effort to move (approaching and breaching resistance/support)
- gapping through resistance/support
- background signs of accumulation distribution


This is mainly what I look for. The issue I have is whether to enter on these breakouts or wait for confirmation. I'm sure you can understand how this is confusing for a beginner? There has to be reasons why sometimes I should enter on the breakout and others I should wait for confirmation?

 

[Wysiwyg]

You can use Fibonacci retracement in conjunction with an oscillator to aim for an entry point.

As an example:-

Right now I am watching the price play on this chart because the company fundamentals are sound enough for me and I envisage a continuation when this retracement is complete. The formation of a hammer candle today poses the question is the retracement over but I think the general market trend will determine the full extent to a certain degree.

I have a question and that is ... High and Low tails are commonly used as point to point on a Fibonacci rather than the open and close of the highest/lowest bar. Personal preferences??

 

[ginar]

Darvas has some good stuff on breakouts . I generally look for a range repetition . trendline breaks are more reliable than any oscillator , fibs are only really useful in hindsite to judge strengths of pullbacks or breakouts . I keep it simple and use structure (price action) as my focus . im a huge believer in the KISS principle , has served me well

 

[pavilion103]

I am struggling to determine when to enter on the breakout and when to wait for the pullback. The below example is not the best one but just used to illustrate a point.

It is a potential short trade as it breaks through support. If I had entered on the green box (although there probably isn't enough info at this point) my entry would be 6.7% from initial stop loss. If I were to wait for confirmation the next day (purple box) entry would then by 12.9% from initial stop which looks too wide.

If I were to wait for confirmation and enter on the purple box bar then WHERE WOULD I PUT MY INITIAL STOP?

Once again, I know this is not the best example but I simply use it to pose the question. Where am I going wrong?

 

[tech/a]

Its not too wide.
All you do is adjust your position size.
You can move your stop down to trail as soon as you like. Thus deminishing your Risk quickly.
In doing so though you may choke the trade.I tend to move stops only when I see a clear support or resistance zone---either in price or volume or both.

Just on this chart it is in wave 3 and nearing completion (1.618 to 2 x Wave 1) so wave 4 is near before finailsing to wave 5.
Bottom line is ther isnt a great deal left in this so would be one I would not consider---unless it was for a short quick trade.

 

[pavilion103]

Its not too wide.
All you do is adjust your position size.
You can move your stop down to trail as soon as you like. Thus deminishing your Risk quickly.
In doing so though you may choke the trade.I tend to move stops only when I see a clear support or resistance zone---either in price or volume or both.

Just on this chart it is in wave 3 and nearing completion (1.618 to 2 x Wave 1) so wave 4 is near before finailsing to wave 5.
Bottom line is ther isnt a great deal left in this so would be one I would not consider---unless it was for a short quick trade.

Maybe I am missing something enormous Tech.
This is how I position size for all my trades.

Entry: $2.40
Initial Stop: $2.09
So entry price is $0.31 from stop loss (around 12.9%)

Risk = $20,000 account x 1% = $200 per trade

Position size = $200/0.31
= 645 shares
Position = $1,348

What do you mean by adjust the position size. Can you show me using this example?


Also do you take the waves into consideration for all trades? I don't know anything about them, so can't even identify them on this chart!

 

[tech/a]

Maybe I am missing something enormous Tech.
This is how I position size for all my trades.

Entry: $2.40
Initial Stop: $2.09
So entry price is $0.31 from stop loss (around 12.9%)

Risk = $20,000 account x 1% = $200 per trade

Position size = $200/0.31
= 645 shares
Position = $1,348

What do you mean by adjust the position size. Can you show me using this example?


Also do you take the waves into consideration for all trades? I don't know anything about them, so can't even identify them on this chart!

So entry price is $0.31 from stop loss (around 12.9%)

Simply the closer your stop is to the entry price the more stock youll buy.
Further away less stock.---thats all

As for waves its not that hard---do some reading and youll soon see them.