What is a pullback?
A withdrawal is a moderate pause or drop in a stock or commodity price chart from recent spikes that occur in a continuous uptrend. A withdrawal is very similar to a retracement or consolidation, and the terms are sometimes used interchangeably. The term withdrawal is generally applied to price drops that are of relatively short duration – for example, a few consecutive sessions – before the uptrend resumes.
Key points to remember
- A withdrawal is a short pause or a short reversal of the action of the prices of a stock or commodity.
- The duration of a pullback is generally only a few consecutive sessions. A longer pause before the uptrend resumes is generally called consolidation.
- Withdrawals can provide an entry point for traders looking to take a position when other technical indicators remain bullish.
What does a withdrawal tell you?
Withdrawals are generally viewed as buying opportunities after a security has experienced a significant upward movement. For example, a stock may go up significantly following an announcement of positive earnings, and then experience a decline when traders with existing positions remove profit from the table. The positive profits, however, are a fundamental signal that suggests that the stock will resume its uptrend.
Most withdrawals imply that the price of a security moves to a technical support area, such as a moving average or a pivot point, before resuming its uptrend. Traders should carefully monitor these key support areas, as a breakdown of these could signal a reversal rather than a withdrawal.
Example of using a pullback
Withdrawals generally do not change the underlying fundamental narrative that guides price action on a chart. These are generally opportunities for profit taking following a sharp rise in the price of a security. For example, a company can report explosive profits and see its shares jump 20%. The stock could fall the next day, as short-term traders freeze their profits. However, the solid earnings report suggests that the company behind the stock is doing something right. Traders and investors who buy and hold will likely be attracted to the stock by solid earnings reports, supporting a strong bullish trend in the near term.
Each stock chart contains examples of downturns against the backdrop of an extended uptrend. Although these withdrawals are easy to spot in retrospect, they can be more difficult to assess for investors holding a stock that is losing value.
In the example above, the SPDR S&P 500 ETF (SPY) is experiencing four withdrawals against the backdrop of a prolonged upward trend. These withdrawals generally involved a move close to the 50-day moving average where there was technical support before a higher rebound. Traders should be sure to use several different technical indicators when evaluating withdrawals to ensure that they do not turn into longer term reversals.
The difference between a reversal and a withdrawal
Withdrawals and inversions both involve security breaking away from its peaks, but withdrawals are temporary and inversions are longer term. So how can traders distinguish the two? Most takeovers involve a change in the underlying fundamentals of a security that forces the market to reassess its value. For example, a company can declare disastrous profits that force investors to recalculate the net present value of a stock. Likewise, it could be a negative settlement, a new competitor releasing a product or another event that will have a long-term impact on the company underlying the action.
These events, while occurring outside of the graph, so to speak, will appear over several sessions and initially resemble a setback. For this reason, traders use moving averages, trend lines and trading bands to signal when a decline continues and risks entering reversal territory.
Limitations of trading on withdrawals
The biggest limitation of trading withdrawals is that a withdrawal could be the start of a true reversal. Since withdrawals and inversions occur over a range of time frames, including intraday if you want to go granular, a trader’s multi-session withdrawal is actually a reversal for a day trader looking at the same chart. If price action breaks the trend line for your calendar, you may be considering a reversal rather than a withdrawal.
In this case, this is not the time to enter the bullish position. Of course, adding other technical indicators and fundamental data analyzes to the combination will increase the trader’s confidence in identifying withdrawals from true reversals.