The chart pattern most hated by novice traders

A comment that came up a number of times after last week’s email was “what the heck is a throwback?”

So, I thought I’d clear that up this week.

Throwbacks, and their opposite number, pullbacks, are loathed by many novice traders.

They are the chart patterns that probably cause more panicked early exits than any other. But, once you realise that the market follows this pattern at least 20% of the time, probably more, you can be prepared for it – and even use it to your advantage.

In fact, if you learn how to trade pullbacks and throwbacks, they can become one of your best friends.

This is how they work …

A throwback occurs when the price has broken an area of resistance, and then retraces to that former resistance level (now support) and bounces off that.

A pullback is the mirror image – price breaks below support and then retraces back to that support-turned-resistance level.

So, what happens to the less-experienced trader is that they’ll enter a trade where the key level is broken. No sooner are they in the trade than the market reverses, straight back to the resistance/support level – putting their trade into negative territory immediately.

This is where our novice trader panics – assuming the set-up must be wrong.

However, the trader who knows about throwbacks and pullbacks will keep his or her calm. This trader may not even have entered the trade yet – because they may be waiting for exactly this situation so they can take advantage of the perfect entry level.

Why the market pulls and throws

When the price breaks through an area of support or resistance, there will inevitably be a bunch of limit orders just the other side of that key level. As these get hit, there is a chance that the price will be knocked back, towards the key level.

This is one of the causes of throwbacks and pullbacks.

If you scan through some old price charts, you’ll notice that these aren’t uncommon events.

The areas on a price chart where we look to get into our trades are by definition the “messy” areas of the charts – they are where prices are consolidating, where traders are getting in and out of trades, and where stop-loss hunters lie in wait.

So, as traders, it is important that we become comfortable with this “messiness” – and avoid getting fazed when charts don’t look like the ones in text books.

Here’s a real-life example of what a throwback could look like, rather than the text-book example shown earlier …

This throwback clearly shows why we need to be mindful of where we place our stop losses on a breakout trade – not too near to the key level.

However, there’s a way to use our throwback to get into a trade at a far better price, which means that we can confidently put our stop loss well out of reach …

Take another look at the chart above, and consider where you’d get into a long trade, if you were looking to trade the breakout of the red resistance level?

The price broke this level with some hefty momentum, so you’d have missed a fair proportion of that move.

However, if you waited for a throwback, and a second entry, you’d be able to enter your long trade at a lower price. Not only would this enable you to enjoy better profits from the subsequent move – it would also mean that for the same risk, your stop loss level could be considerably lower.

Here’s another example …

Again, by waiting for a pullback, we’re able to enter a sell trade at price B instead of price A. Level B is 25 points higher – that means we’re able to make 25 points more profit, PLUS, we’re able to tuck our stop level 25 points further from danger, at no extra cost!

Of course, throwbacks and pullbacks don’t happen on every breakout, but it’s worth remember that they are pretty common, especially where a price has broken with some momentum, which is exactly the times that we miss good entry levels first time around.

Once we get used to anticipating these market patterns, they can become our best friends, instead of our worst enemies!

Related posts:

How to double your money – when the price goes the wrong way How failed chart patterns can be your best friend