What is a pullback in stocks?

A pullback on the stock market is a short-term drop or a pause in the long-term uptrend. Usually this is followed by a new rise to a higher level. It often occurs after a significant rise in price and typically results in the price being below the original high. The term pullback is often used interchangeably with the terms consolidation or retracement. However, the term pullback refers to shorter in duration price drops.

There are other terms describing drops in price, that is correction and reversal. Though pullbacks are brief declines of 5% to 10%, corrections are 10% to 20% and reversals are over 20%.

How a pullback works

The reasons behind pullbacks are explained simply with the supply and demand ratio. To put it simply, when the stock price increases, short sellers enter the market and buyers prefer to leave. As a result, when the short sellers hastily close their positions and the buyers pounce on the stock again, the market bounces back instantly in the direction of the main trend. Therefore, demand for the asset does not let it fall, keeping the price at a certain level.

Trends do not last forever and eventually they end. So you have to be careful, there is always a chance that what appears to be another pullback is actually a trend reversal. The more times a stock pulls back and resumes its trend, the less likely it is that the trend will pick up again after the next pullback. In other words, early pullbacks give a better chance of trend continuation.

How to trade with pullback

How to trade trend pullbacks might appear a tricky question, because you have to make a choice:

to take no action and wait for the trend to resume;

to close the position and open a new one when the trend resumes;

to trade against the trend until the pullback is over.

Long-term traders prefer to wait out pullbacks. They almost always have the fundamental data on hand, confirming the imminent resumption of the trend. Swing traders use the standard practice of closing a trade and reopening it after a pullback, which is actually the best way to trade on pullbacks.

When dealing with pullbacks, the most important thing is to establish the moment when the correction begins and ends (or when it transitions into a reversal). To determine the beginning of a pullback, traders usually use momentum indicators.

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2022-11-22 • Updated

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