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Play the Pullback
By Greg Guenthner
February 2, 2011
Dear Penny Sleuther,
During a roaring bull market, you can sometimes get away with buying less-than-ideal set-ups. The rising tide will usually bail you out of any imperfect trades. Yet so far in 2011, the choppy market isn’t handing out free money. You simply cannot afford to be sloppy in your trading.
Over the past several weeks, I’ve written a great deal on strategies to help you manage your trades, along with set-ups to avoid as the market became overheated.
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Today, I want to expand on this theme by discussing an ideal risk vs. reward trade. By incorporating this setup into your scans, I can all but guarantee that you will increase your winning percentage by limiting your trading to only the most favorable opportunities on the market.
We’re all aware that stocks will not go up indefinitely. Even the strongest uptrend needs a break to properly consolidate. You need to be able to find and exploit the best consolidation set-ups in order to successfully navigate current market conditions. These are the stocks that have the best chance at continuing their uptrends when the market rights itself. In order to help you properly identify the best pullbacks of uptrending stocks, I’ve listed some important tips below.
For our example setup, take a look at the following chart snippet:
First, I want you to note the moving averages. In this example, I’ve added the 10- (green), 20- (red) and 50-day (blue) moving averages. When planning a pullback trade, you always want to find the short-term moving average that the stock obeys.
Aside from a sharp break in November that quickly recovered, you can see that this particular stock is obeying its 20-day moving average. With this important point identified, we can use the moving average as a guide for our entry and stop loss.
Now that the uptrend’s support has been established, you have to examine the trading volume to ensure the stock is consolidating properly. Ideally, you are going to want a stock that shows fading volume as it retraces toward support (red lines). If you see any big red volume bars, you might want to reconsider the trade. For this strategy, the volume pattern is just as important as the price action.
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In order to pinpoint the right time to buy, simply wait out the consolidation pattern. Your buy signal will occur on the day that the stock bounces off support (blue arrows) on higher relative volume (blue circles). In our example, there are two strong buy indicators flashing in December.
All that remains is setting your stop loss just a few cents below support — which in our example is the 20-day moving average. A low-risk trade following our example is the perfect maneuver in this choppy market. It gives you the opportunity to set a tight stop loss while reaping the benefits of a strong stock bouncing off support.
Sincerely,
Greg Guenthner
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Choppy Market Trading Strategies: Play the Pullback is featured at Penny Sleuth.
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