How profitable is this strategy?
We’re glad you asked! Here’s 2nd Lieutenant Pontus’ results on a live account, he practically doubled his account in 1 month! :
1. What is a breakout pullback strategy?
A breakout pullback strategy is one where we wait for price to make a breakout past a previous swing high or swing low (meaning there is a strong surge of buyers or sellers at that point that pushes to price up/down strongly) and after which, we wait for a pullback right to the level at which price had broken out to enter a trade. The bar at which the breakout occurs is usually larger than the average bar.
The indicator you see above is the TFA Breakout Pullback Radar Indicator. Its sole purpose is to identify ‘pullback levels’ after a breakout has occurred. After much feedback, we have made a lot of changes to this indicator to allow it to filter better pullback levels.
Explanation of settings :
lookBackBars : This simply means how far back you want the indicator to scan for breakout pullback levels. A value of 1,000 is usually more than enough.
swingBarSensitivity : This measures how ‘sensitive’ you want the swing high/low level to be. A value of 1 means all you need for a swing high is one lower bar on the left and one lower bar on the right. The problem with this is it gives you a lot of false ‘swings’. A value of 3 to 5 is most optimal here.
atrPeriod : This is a measure of how many bars back you want to use to measure the Average True Range.
atrFactor : The bigger this value, the bigger the breakout bar has to be to ‘qualify’ as a breakout bar.
flagCalculationZoneWidthInPips : This value is for the sensitivity of the Flag Formation. Leave this value at 100.
flagTriggerValue : This value is the minimum strength required of the Flag Formation when it is in your favour. Leave this value at 2.
Max Candle Shadow For Break Out Bar : When a breakout bar occurs, we naturally do not like it to have large shadows/wicks, we like it to be one solid breakout bar with little or no shadows/wicks. This value is the percentage (%) of the bar you would allow to comprise of a shadow. 30% is usually a good gauge.
Is swing hit only body : If this is true, it ignores the shadows/wicks of a potential breakout bar and instead continues searching for breakout bars that breaks the swing high/low with their body (instead of their shadow).
DZ Zone Offset Low/High Volatility : Leave this value as they are. They are used to measure when price had entered into the DZ area and when it does, it paints a little arrow above/below it to inform you of it.
Bullish/Bearish Break Out Bar High/Low Filter, % : Naturally, a breakout bar is most effective when it breaks the swing high/low somewhere in the middle 80% of its body. This value lets you filter off the top/bottom % of the bullish breakout bar that you do not allow to break the swing high/low. Basically, a value of 10/10/10/10 means that you do not allow swing breaks to occur as logn as they fall within the top/bottom 10% of the breakout bar.
2. The psychology behind a breakout pullback strategy
If you guys known me well enough, you would know that I love to analyze every strategy from a holistic view and in this case, from a psychological perspective on why such strategies are so powerful and profitable.
Referring to the image above, you can see that the candle at which the breakout occurred (the big green candle) is a candle larger than the average candle. What is happening here is that there are a huge influx of breakout buyers jumping into the market to push the price up so strongly – a lot of people are holding long positions at this area. These guys are just praying and hoping that more buyers would jump into the market with them to push the price up.
Now, what happens after a breakout? The pullback of course. The pullback is when novice traders (and there are a lot of them) go something like this : “Oh the market is rising fast, I better get into the move and catch it in case I miss out on it!” – this is the stage where they are buying all the positions that the breakout traders are now happily selling and unloading onto them. At this stage, you can see the price going down back to the horizontal line we drew at which the breakout occurred.
When price finally reaches that level and many of the novice traders have been stopped out, there is where traders of the breakout pullback strategy comes in. Previous resistance has now turned into support and in trading terminology, this is called a key graphical overlap and many traders like to play these levels and it’s normal to see an influx of buyers into this level.
3. The magic of Fibonacci and Elliott Wave theory at this pullback level (advanced)
Alright, this section is for the more advanced traders who like to better understand the logic behind a breakout pullback strategy trade. Again, if you know me well enough, you know I am in love with the art of Fibonacci and Elliott Wave theory.
At this stage when price has did its pullback, it would be great to enter as after a strong breakout (likely an impulsive Elliott Wave 1 or 3), we would see a small correction (either wave 2 or wave 4 correction in terms of Elliott wave structure) before we see another push up (which we’re expecting to play with this graphical overlap). You can read more about some of the Fibonacci Retracement levels to get a better understanding of what I just explained. Now, you don’t have to fully understand this part but for those of you who know Elliott Wave structure, wave 4 never goes into wave 1 territory (meaning it never breaks the graphical overlap) so if the last swing high was the top of wave 1, the pullback you’re seeing is the wave 4 and it’s an irrefutable law that it must not go into wave 1 (so it would likely bounce).
This picture roughly explains what I mean by this.
(explanation of the image above)
As you can see, wave 4 is not allowed to cross back into the top of wave 1. In this case, if you put the price in close (instead of candlesticks) you will notice that they do not overlap. This is a key area to buy into.
So anyway, this is just one of the reasons buying a graphical pullback can be very profitable especially when the initial swing high/low was broken by a larger than average bar as mentioned by Pontus. It’s important to not only use strategies, but to understand them from a holistic perspective.
4. Use the Advanced Fibonacci Waves
The next thing we need to do is load 9 time frames of advanced fibonacci waves onto your 5 minute chart to give you a better understanding of how the market is flowing. The key here is to see the market move in it’s entirety instead of looking at individual fibonacci waves. Are there more waves below price than there is above price? If there is, that means there is more support and price will tend to be more bullish. The following picture would give you a better understanding of this :
(explanation of the above picture)
As you can see, there is a lot more blue vs orange, meaning there is a lot more support vs resistance. This gives you a general idea of where the market is heading and that is has a bullish bias.
5. Flag Formation Filter
One of the key requirements is there to be a flag formation in your favor. The reason for this is you’re buying a pullback and you would require the momentum of the currency pair to aid you in your trade.
So if you’re buying a bullish pullback, you would look at the currency pair and see if there’s a Bull Flag Formation of at least 2.0 in your favour.
If you’re selling a bearish pullback, you would similarly look at the currency pair and see if there’s a Bear Flag Formation of at least 2.0 in your favour.
6. Exact Entry Requirements
Alright, now that you know how to set everything up, here’s the exact entry requirements for the breakout pullback strategy trade.
1) Breakout from a swing high or swing low and the breakout bar has to be larger than the average bar
2) Price does a pullback to the horizontal line at which the breakout occured
3) If you’re doing a long trade, the Bullish Flag Formation value has to be above 2.0.
If you’re doing a short trade, the Bearish Flag Formation value has to be above 2.0.
4) In the previous 3 bars, price should have hit the DZ zone at least once.
Update : After much feedback that it is hard to monitor 20+ charts on whether a DZ zone has been hit by the 5 minute candle, we have developed a feature in the TFA Breakout Pullback Radar Indicator that paints an arrow on top/below bars which have entered into the DZ zone.
5) Enter once price touches the horizontal line, you do not need to wait for the bar to close
Additional ways to improve your accuracy and profitability with these trades :
6) Add the fibonacci element : When you have identified the breakout pullback level, it helps to see if it falls on a fibonacci retracement level (usually 38%, 62%). If it does, you could increase the risk you take on this trade slightly.
7) Add the mathematical indicators element : When price is right at the pullback level, it helps to check with the mathematical indicators (Stochastics, RSI, MACD) if it is also at some sort of support/resistance which can signal a reversal too.
8) Add the graphical element : Draw horizontal lines, descending lines and channels. Does this pullback level coincide with a previous level strongly?
9) Avoid high spread pairs : If there is a similar entry on EURUSD and EURAUD (0.1 pip spread vs 2.0 pip spread), always pick the major pairs which are much more liquid and have better spreads. In a tight scalping world, such fine margins matter.
7. Stop Loss and Take Profit Handling
There are 2 methods to implementing the stop loss, one more conservative than the other.
1st Stop Loss Method : Use the bar that initiated the breakout
Set the stop loss 1 pip + spread below the bar for a long trade or above the bar for a short trade. This method will get stopped out a bit more often but can give you a great risk : reward ratio
1st Take Profit Method (when using 1st Stop Loss Method) : Set TP at 1R:1R.
Meaning if SL is 15 pips, TP should be at 15 pips too.
2nd Stop Loss Method : For long trades, use the lowest low between the swing high and the breakout. For short trades, use the highest high between the swing low and the breakout.
Set the stop loss 1 pip + spread below the lowest low for a long trade and above the highest high for a short trade.
2nd Take Profit Method (when using 2nd Stop Loss Method) :
For long trades, measure the distance between the horizontal line and the lowest low between the swing high and the breakout and use that distance in pips as your take profit. Take 50% profit when the market has moved 50% towards your take profit target and then move the stop loss to Break Even for the remaining position.
For short trades, do the opposite.