Market Pullbacks are scenarios wherein prices would revert back with a short move right after a market expansion. This often causes the market to be slightly oversold or overbought on the short term against the long-term trend. These scenarios present an excellent trading opportunity for traders who can time their trades correctly in anticipation of a market pullback. This is the type of trading strategy that we are about to discuss here.
Tick Based Stochastic Histogram Indicator
Tick-Based Stochastic Histogram Indicator, also called TBS Histogram Indicator, is a momentum indicator which is based on the classic Stochastic Oscillator. Just as with the Stochastic Oscillator, TBS Histogram was also developed to help us identify the direction of the market’s momentum.
It also provides a systematic approach for identifying oversold and overbought markets, as well as potential mean reversals coming from such overextended price ranges. Both indicators plot two oscillator lines that are used in tandem to identify the direction of the market’s momentum. These lines also oscillate within a fixed range. Aside from this, both of them also have markers to indicate oversold and overbought market levels.
The TBS Histogram lines oscillate within a range of -60 to +60 and has a midrange of zero. Positive oscillator lines indicate a bullish momentum, while negative lines indicate a bearish momentum.
We can also identify the direction of the short-term momentum based on how the two lines overlap. Momentum is bullish whenever the green line is above the red line, and bearish when the two lines overlap in reverse.
This is also aided by histogram bars which oscillate around zero. It plots a positive bar whenever the green line is at the top, and a negative bar whenever the green line is at the bottom. The color of the bars is dependent on whether the histogram value is increasing or decreasing.
The oversold and overbought markers are at -30 and +30. Lines dropping below -30 indicate an oversold market, while lines breaching above 30 indicate an overbought market. Crossovers between the two lines that develop on these areas are considered mean reversal signals.
Supertrend Indicator
Supertrend Indicator is a trend direction indicator that is based on the concept of using the Average True Range (ATR) as a basis for identifying trend direction or the nullification thereof.
One of the ways traders identify trend reversals is based on the idea that price should not reverse against the current trend direction too much. Price may pull back as it oscillates naturally, but the pullback should not be significant. With that in mind, traders use a multiple of the ATR to quantify price movements and qualify acceptable pullbacks and actual trend reversals.
One of the most popular parameters when using the ATR as a basis for identifying trends and trend reversals is the multiple of 3. In this case, the ATR is multiplied by 3. This value is then subtracted to the highest high or added to the lowest low within a given period, depending on the identified trend direction. If the market is in an uptrend, we subtract the value from the highest high.
Inversely, if the market is in a downtrend, we add the value to the lowest low. The resulting values become the thresholds wherein if breached, would then indicate a trend reversal. For example, in an uptrend, if a price drops below the difference between the highest high and the product of the ATR multiplied by three, then the uptrend is nullified and replaced by a downtrend.
The Supertrend Indicator simply provides a visual representation of the thresholds based on the concept discussed above. In an uptrend, it plots a green line below price action with a pale green filling between the price and the line. On the other hand, the indicator plots a red line above price action with a bisque filling between the price and the line during a downtrend. Trend reversals are identified whenever price action crosses over the line and closes on the opposite side.
Given these features, we can then use the Supertrend Indicator as a trend reversal signal indicator, a trend direction filter, or a basis for placing and trailing our stop loss levels.
Trading Strategy Concept
The trading strategy that we are about to show is a trend continuation strategy that trades on the short-term mean reversal signals that are in confluence with the trend direction. These scenarios typically occur right at the end of a market pullback.
We will be using the Supertrend Indicator to identify trend direction. As such, the trend will be based on the location of price action about the Supertrend line, as well as the color of its filling. However, the trend direction should also be confirmed based on price action.
After identifying the trend direction, we could then identify trading opportunities based on the TBS Histogram Indicator. The market should pull back after a market expansion phase. This pullback may cause the TBS Histogram lines to indicate an oversold or overbought level, depending on the direction of the trend. The crossover between its two lines, as well as the shifting of the histogram bars around zero, will indicate our entry signal.
Buy Trade Setup
Entry
- Price Action should be above a green Supertrend line.
- Price should pull back causing the TBS Histogram lines to drop below -30.
- Open a buy order as soon as the green line crosses above the red line and the histogram bars shift above zero.
Stop Loss
- Set the stop loss on the fractal below the entry candle.
Exit
- Close the trade as soon as price action shows signs of a momentum reversal.
Sell Trade Setup
Entry
- Price Action should be below a red Supertrend line.
- Price should pull back causing the TBS Histogram lines to breach above 30.
- Open a sell order as soon as the green line crosses below the red line and the histogram bars shift below zero.
Stop Loss
- Set the stop loss on the fractal above the entry candle.
Exit
- Close the trade as soon as price action shows signs of a momentum reversal.
Conclusion
Trading market pullbacks in a trending market is one of the most basic trading strategies that seasoned traders use. This strategy simply gives a structured approach on how to trade in this manner. If you are keen on trading market pullbacks in confluence with the trend, then study and test this strategy using the attached indicators.
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