Step-by-step guide in how to trade with breakout pullback, with examples

TL;DR: Traders often enter a trade as soon as they identify a breakout. However, this approach can be riskier as it may not be able to withstand false breakouts. The Breakout Pullback strategy, on the other hand, offers traders a lower level of risk while aiming for a higher return.

What is a Breakout Pullback?

Breakout pullback is a popular and effective trading strategy used by traders to take advantage of the resumption of a trend after a period of consolidation. In any trading market, price movements often alternate between periods of consolidation and trending phases. Consolidation patterns represent a temporary pause in the market as buyers and sellers reach an equilibrium. These patterns are significant because they indicate potential breakouts, making them the most popular patterns to recognize.

However, entering a trade the moment a breakout is recognized can be risky, as there is a chance it could be a fake breakout. To increase the probability of success, traders should wait for a breakout from the consolidation pattern and then execute a trade during the subsequent pullback. This allows them to position themselves to benefit from the high probability of the underlying trend resuming.

How to Trade a Breakout Pullback Step-by-step

Step 1: Identification of a consolidation pattern

Consolidation patterns, such as wedges, triangles, and rectangles, are periods of price consolidation where the asset’s price moves within a specific range. These patterns indicate a temporary pause in the market before a potential breakout occurs. Traders need to patiently wait for the price to break out of the consolidation pattern, signaling the resumption of the underlying trend.

Taking the example of C3.AI ($AI) stock, after a bullish uptrend, the asset entered a consolidation period during which it formed a descending triangle pattern. We can anticipate a strong move following the breakout from this pattern.

Step 2: Breakouts, WAIT!

Once the breakout occurs, the next step is to wait for the price to pull back to a support or resistance level. This pullback provides an opportunity for traders to enter the trade at a more favorable price with stronger confidence. The pullback serves as a confirmation that the breakout is valid and the market is testing the previous support or resistance level. By waiting for the pullback, traders can increase their probability of success by entering the trade at a lower risk point.

Once again, focusing on C3.ai after the breakout, there is a strategy to enter the market immediately after observing the breakout. However, this move carries more risk as the significant increase resulting from the breakout may be short-lived. Consequently, we may witness a rapid decline in price, testing the support level.

Step 3: Enter the trade

After the pullback, traders can enter a trade in the direction of the breakout. For example, if the price breaks out to the upside, indicating a bullish breakout, traders can consider entering a long trade when price rebound at support level. Conversely, if the price breaks out to the downside, indicating a bearish breakout, traders can consider entering a short trade after the price rebound from the resistance level. Therefore, patience and discipline are key when executing a breakout pullback strategy.

Returning to the example of C3.ai, we patiently wait for a pullback to occur near the support level. We use the TradeDots indicator as a confirmation signal. The appearance of double bottom red dots confirms that the asset price remains above the support level. Therefore, we can enter the trade at that time.

Step 4: Placing stop-loss and profit target

The stop-loss should be placed below the support level if trading a bullish breakout, or above the resistance level if trading a bearish breakout. This helps to limit potential losses in case the market reverses. The profit target, on the other hand, can be based on the size of the consolidation pattern. Traders can measure the distance between the highest and lowest points of the pattern and project that distance from the breakout point to estimate a potential target level. However, it’s important to remain flexible and adjust the profit target based on market conditions and price action.

After entering the trade near the support level, we set a stop loss slightly below the support level and utilize the previous resistance level as our take profit targets. By making use of the TradeDots indicator, we can refer to the green dots to identify previous market pivot points that serve as price resistance.

Bottom line

Breakout pullbacks are a popular trading strategy that allows traders to capitalize on the resumption of a trend following a period of consolidation. When trading with this strategy, remember that “Patience is key”. In the next blogs, we will talk about the tips and mistakes that traders make when trading with breakout pullbacks. Make sure to follow, and subscribe to our official channels to learn more about trading and technical analysis.

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Disclaimer: The information provided in this article is for educational purposes only and should not be considered as financial advice. Trading involves risk, and it is important to conduct thorough research and seek professional guidance before making any investment decisions. Prospective investors are encouraged to perform their own due diligence or consult a financial advisor before making investment decisions.