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While these pullbacks are easy to spot in retrospect, they can be harder to assess for investors holding a security that’s losing value.
In the example above, the SPDR S&P 500 ETF (SPY) experiences four pullbacks within the context of a prolonged trend higher.
These pullbacks typically involved a move to near the 50-day moving average where there was technical support before a rebound higher.
Traders should be sure to use several different technical indicators when assessing pullbacks to ensure that they don’t turn into longer-term reversals.
Pullbacks and reversals both involve a security moving off its highs, but pullbacks are temporary and reversals are longer term. Most reversals involve some change in a security’s underlying fundamentals that force the market to reevaluate its value.
For example, a company may report disastrous earnings that make investors recalculate a stock’s net present value.
Pullbacks are widely seen as buying opportunities after a security has experienced a large upward price movement.
For example, a stock may experience a significant rise following a positive earnings announcement and then experience a pullback as traders with existing positions take profit off the table.
The term pullback is usually applied to pricing drops that are relatively short in duration - for example, a few consecutive sessions - before the uptrend resumes.
In which case, it is not the time to enter a bullish position.
Of course, adding other technical indicators and fundamental data scans to the mix will increase a trader's confidence in identifying pullbacks from true reversals.
Being that both pullbacks and reversals happen on a range of timeframes, including intraday if you want to go granular, one trader's multi-session pullback is actually a reversal for a day trader looking at the same chart.
If the price action breaks the trendline for your timeframe, then you may be looking at a reversal rather than a pullback.