From retreat to attack: In this way, you act with less risk from the correction.

One approach that is often mentioned in the literature, among other things, is that due to the better opportunity/risk ratio (CRV), the correction should be followed by trading in the prevailing trend direction.

However, loss trades are more common, since an arbitrary entry into a running correction with tight stops is comparable to "gripping a falling knife".
Minimizing these losses and thus trading at lower risk can be done by means of the "pull back strategy", in which the entry point is specified more precisely and fewer signals are traded, but which have a higher probability of hitting.

The basic idea of this trend-following trading strategy is based on the classic trend definition according to the Dow Theory, where it is more likely that a stock continues its established trend direction and on the other hand prices have the tendency to correct in the opposite direction to the trend and then turn back into the original trend direction and thus finally continue it.

Now, in principle, any correction could be traded stubbornly, quasi "mechanically", in a correction trade.
However, such unreflective trading would then also result in more loss trades.

The retraction strategy minimizes false signals and losses and at the same time helps us to create a duplicable set of rules that indicates entry signals in the correction according to objective criteria.

The share strategy

The trading strategy, which is presented in this paper on a daily basis, can be divided into three main parts, namely a filter which clarifies the precondition, the actual setup with the concrete entry rules and the trade management in case of loss and profit.

In the following, the strategy is explained on the basis of a long scenario. Of course, the concept described also applies analogously to the short side.

 

1. precondition for the equity strategy "price correction

First of all, there must be a value that is in an upward trend and whose price is currently quoted above the moving exponential average (EMA) 50 and 200 (a simple moving average, etc. would also be possible, but the EMA is used in this article).

Furthermore, an upward trend must be established. This can be a young trend or a trend phase that has already lasted for some time. These preconditions can be checked manually or can be easily pre-filtered automatically with a chart software screening, for example, by measuring the percentage distance to the EMA 50 and 200, the ADX which is quoted for a certain time over 30, or the distance to the previous high of the last X days, etc.

 

2. setup for the equity strategy "price correction

The setup is initiated by an incipient correction in which the price starts to fall from its recent relative high (RH) towards and touches the 50 GD (condition day).
Please note, however, that the course of the price must not fall below the 50s GD on a closing price basis for two consecutive periods, because then the momentum may be reduced in the short to medium term.
By the filter and in particular the condition of the not significant undercutting of the 50s GDs mainly strongly tending values with large momentum are selected, which have the increased chance to rise further in trend direction with impulsive movements and only these values should be traded.

Only when the above-mentioned constellation is present is the pre-filtered value suitable as a potential trading candidate.

This setup is schematically illustrated in Figure 1.

 

3. entry for the stock strategy "price correction

Entry is only made if the price trend gives reason to believe that the correction may have come to an end and the main trend is now resumed. This is the case if within a correction after several downward candles (see also picture B2) and the contact of the 50 GDs a candle is present which closes above the previous candle.

In order to be able to trade this assumption now, it is necessary as soon as the price touches the 50 GD on the "condition day" that an order is placed directly above the high of the candle touching the 50 GD.

Now this buy order remains in the market until it is executed or the price continues to fall below the low of the condition day candle or falls below the 50 GD on a closing price basis for two consecutive days. If these alternatives occur, the scenario is invalid and the buy order is cancelled.

Figure 2 illustrates the concrete entry and the order situation.

 

4. stopping the share strategy "price correction

The initial stop is just below the "condition day" candle.

A trailing stop is always followed by each following candle on a closing price basis, always just below the previous period.

 

5. profit taking Share strategy

The profit taking is done by the market itself, i.e. the stops are retracted until the market "picks up" the stops and thus removes the position.

 

Practical examples for the equity strategy

The example in Figure 3 is intended to show concretely how the trading strategy is used in practice.

 

The chart shows a daily chart of BASF shares for the period May 14 to November 29, 2013.

After a downward trend, a new young upward trend began to form from August 2013, which established itself with the second relative high in mid-September. At the same time, the share price has also been trading above the EMA 50 and 200 since mid-September.

From 19.09. onwards a correction phase within the new upward-trend began. On 07.10. the price touched the EMA 50, so that a buy order could be placed just above the high of 07.10. at 70.42. This order was then triggered on 10.10. and an initial stop was placed in the market immediately below the low of 07.10. at 69.13. By means of a trailing stop, the stop was successively pulled back to the previous candle with each new candle.

On 05.11., the stop that had been drawn in this way was triggered just below the low of 04.11. at 75.91, which led to a CRV of around + 3.4 R.

The example in Figure 4, based on the Daimler share, shows very nicely that the "exit strategy" by no means always leads only to big winners.

 

The chart shows the Daimler share in the daily chart from April 16 to November 29.

The share was in an upward trend and since mid-May the share price was quoted above the EMA 50 and 200. On 26 August it began to correct and on 28 August the price touched the EMA 50. After that a buy order was placed just above the high of 28 August at 52.82. This order was then also executed on 29.08. Due to the gradually tightened stop on the previous day's candle, the stop was brought up to the low of the previous candle below 52.84 on 03.09., in order to then be stopped immediately on 04.09. and end the trade with plus-minus-zero.

 

Possible modifications to the equity strategy

Of course the withdrawal strategy can be combined with other elements of technical analysis. For example, the use of Fibonacci retracements, which then coincide with the EMA 50 at best, is a sensible combination. It is also possible to include the uptrend and location of relative highs and the correction levels to these. This means that if the price in a correction touches the EMA 50 and at the same time this price level coincides at or near the last relative high (see Figure 2 at the 3rd RT point), this can be seen as a further confirming aspect.

 

Conclusion

By strictly applying the rules and regulations, the trading strategy described above helps to ensure that a trade is not entered into at any point within a correction without a plan, but that trades can be entered into at reasonable levels under constantly repeatable conditions with increased probability of profit.
Nevertheless, this trading strategy will not be permanently successful.
However, with strict risk and money management, the winners can more than compensate for the losses and thus achieve a positive return in the long run.

 

Stock Strategy Snapshot

Equity strategy name:

Withdrawal strategy

Equity strategy type:

swing trading

Time horizon:

EoD

Setup:

Long: In a strong uptrend with prices above the EMA 50+200, the investor waits for a correction to the EMA 50, and then trades the possible end of the correction early with tight stops in the original trend direction.
Short: analogue

Get in:

Above the high of the candle touching the EMA 50, in case of a positive follower candle.

Stop loss:

Initial stop at the low of the entry candle, then trailing stop with the respective predecessor candle

Take profit:

Through the market via trailing stop.

Risk management:

0.5 % Per trade