Part III
Pullbacks: Trends Converting to Trading Ranges
Even when a chart is in a strong trend, it will have periods of two-sided trading, but as long as traders believe that the trend will resume, these are only pullbacks. These trading ranges are small enough for traders to view them as just brief pauses in the trend, rather than the dominant feature of the chart. All pullbacks are small trading ranges on the chart that you are viewing, and all trading ranges are pullbacks on higher time frame charts. However, on the chart in front of you, most attempts to break out of a trading range fail, but most attempts to break out of a pullback succeed. On higher time frame charts, the trading range is a simple pullback, and if you are trading on that chart, you can trade it like any other pullback. Since the bars are larger on a higher time frame chart, your risk is greater, and you have to reduce your position size. Most traders prefer to trade off a single time frame and not switch back and forth taking different-sized positions and using different-sized stops and profit targets depending on the time frame.
If the market is in a strong trend and everyone expects the trend to continue, why would a pullback ever happen? To understand why, consider the example of a bull trend. The reversal down into the pullback is due to profit taking by the bulls and, to a lesser extent, scalping by the bears. Bulls will take profits at some point because they know that it is the mathematically optimal ...
