Trading pullbacks

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in foreign exchange

Markets don't move in a straight line, no matter how strong a trend is in force. Pullbacks offer opportunities to take advantage of the natural rhythms in price action.

by barbara rockefeller ven the best-behaved price swing or trend has pullbacks, which are moves of lesser magnitude in the opposite direction of a significant swing or trend.

Traders like the foreign exchange market because currencies tend to move in large swings that mirror big economic trends, such as the emergence of inflation or whether a currency's central bank is on top of things or behind the curve.

What traders don't like are the pullbacks that eat away at

FIGURE 1 — CONTINUATION AND PULLBACKS

The circles mark Bollinger Band penetrations that were followed by pullbacks and then resumptions of the trend or, in the case of the May-June move, a full reversal.

FIGURE 1 — CONTINUATION AND PULLBACKS

Source: Chart — MetaStock by Equis; Data — Reuters

profits. We'd all like to emulate George Soros and take big-picture bets lasting for months, but it's not realistic — few of us have the capital to sit out large countertrend swings.

For example, consider Bollinger Bands. If you're careful and thoughtful, Bollinger Bands, together with other indicators, can help you identify those big swings that can be so profitable in forex. The problem is they don't work very well on the short time frames most of us use.

John Bollinger introduced Bollinger Bands in 1983 in

_ magazine articles and finally delivered a book on them (Bollinger on Bollinger Bands, McGraw-Hill) in 2002. Bollinger Bands are lines placed two standard deviations above and below a 20-period simple moving average (SMA). When price penetrates one of the bands, we expect the "trend" or swing is going to continue in the same direction as this breakout.

In Figure 1, each circle marks where the Swiss franc (SF) futures penetrated either the upper or lower Bollinger Band, but then proceeded to move in the opposite direction for several days — a classic pullback. The May-June move was more than a pullback, it was a reversal: price broke the upper band and went on to break the lower band.

After the initial pullback, price (most of the time) moves in the same direction as the breakout. That means you have to know the time

FIGURE 2 — MOVING AVERAGE CROSSOVERS

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