How to identify a dip or a pullback?

Continuing with yesterday's topic, we need to understand the relevance of trading time scale in discussing dips.

For example, today 3rd Jun 2009, the nifty "dipped" to 4480. This is clearly an intraday dip relevant for day trading but may not be relevant for swing traders or positional traders.

A sudden fall is not a dip. It may be just one leg of consecutive falls. For a sequence of falls to become a dip, it is necessary that the price action starts heading back up. If you are a swing trader trading using EOD price indicators, then a good, working definition of a dip could well be a day which has higher prices for two days before AND two days after. This means if you use this definition of a dip, you cannot detect a dip right at its lowest point. You have to wait for two more days.

There is nothing sacred about the number two. You can have three or five in place of two. Of course the number of days you have before and after will also determine by much you miss the bottom of the dip. In my experience, 2, 3 days work well.

Another way to detect a dip and a pull back would be to use plots of Highs and Lows of the moving averages. If you plot Highs and Lows of 5 days exponential moving average for the last six months, you can see that there are wave patterns which allows you to identify a dip soon after it happens. This is the basic idea. You can choose another time frame to suit your own needs. But once you choose a time frame, stick to it.

Lastly, you must decide on stop loss and when to take profits. We will cover these in later posts.


Disclaimer: The above analysis is just that - my analysis. If you choose to trade on the basis of this analysis, you will be solely responsible for the outcome of the trade - profit or loss. Please keep in mind that day trading is not for the novice and there is significant risk of loss of capital in trading.