3 Ways of Looking at Pullbacks in Stocks

What does a stock look like as its Short Term PowerRating moves into the “Consider Buying” category of 8, 9 or 10?

Traders who are new to our PowerRatings often assume that a stock with a high Short Term PowerRating is a stock that is making new highs or breaking out. Because the financial media equates a good stock with a stock that is going up and a bad stock with a stock that is going down, this is an understandable way of thinking.

Understandable, but problematic. Our research, looking at millions of simulated, short term stock trades between 1995 and 2007, suggests that the best time to buy a stock is not when it is making new highs but, rather, when it is making new short term lows. And when it comes to breakouts, we believe that most traders will do better buying stocks that have made a large move down rather than after stocks have made large moves up.

Click here to read our research on trading stocks that have made large moves to the upside or downside.

There are a variety of different types of pullbacks that traders will notice in stocks that we underscore because of their high Short Term PowerRatings. We discuss these different types of pullbacks, by the way, in our Path to Professional Trading Course. (To register for this free course, click here). In this case, however, I want to show traders how some of the different high PowerRatings stocks actually look as their stock symbols appear on our radar: from those that have begun to pullback but are still several points from nearby support, to those stocks that have just rallied above their 200-day moving averages and now are testing that former resistance level for support, to those stocks that are deeply in pullback mode and are already engaged in a serious test of support at the critical 200-day moving average level.

Let’s look at an example of the first kind of stock: the kind of stock that has had a PowerRatings upgrade and has a low 2-period RSI value, but is still trading far above support. One such stock is Valence Technology Inc.
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, which has a Short Term PowerRating of 9. With a Short Term PowerRating of 9, Valence Technologies belongs to that group of stocks which, according to our research, have outperformed the average stock by more than 13 to 1 after five days.

Stocks like this can be trying for traders who look to buy pullbacks. Although VLNC has a very high Short Term PowerRating and an attractively low 2-period RSI of under 13, the fact that the stock is so far above key support means that it is possible that VLNC will have to move down a great deal before it finds new buyers. For traders who look to buy below the previous close, VLNC may be stubborn about pulling back deeply at first. But it is worth noting that many of the gold and mining shares we told readers about weeks ago also looked a lot like VLNC before they made the kind of deep pullbacks that allowed our readers to get on board at good prices.

Other stocks, such as Terra Industries
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are already well-engaged in major tests of support at the 200-day moving average. Terra Industries also has a Short Term PowerRating of 9.

Terra Industries has been in a slow-motion downtrend since late February. The stock has already tested its 200-day moving average in late March, and looks poised to test that level again in early April. Traders looking at stocks like Terra Industries have to hope that the stock actually breaks down below its 200-day moving average (otherwise a bearish sign) in order to get the sort of weakness that will allow traders to buy in below the previous close. Already deeply oversold, TRA is likely to bounce before continuing any lower.

The last type of high Short Term PowerRatings stock is the kind of stock that was trading below major resistance at the 200-day moving average, has rallied above that level, and is now back to that level testing it for support. Universal Corporation
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is an example of such a stock.

The idea of resistance becoming support is one of the key concepts in technical trading, and is applicable here. When a stock struggles to rally above a certain level – turning that into an area of resistance – and then is finally able to close above that level, it is often the case that the level will become a source of support should the stock pullback and start to move lower.

While no hard and fast law, this phenomenon occurs often enough that traders should be on the look-out for it when it occurs. Generally speaking, support that was previously resistance can be more reliable insofar as the level has likely been seared into the memory of traders involved in the stock.

Here, with Universal Corporation, we see aspects of both the resistance-turned-support pullback as well as the first type of pullback, where the stock is trading several points away from potential support at the 200-day moving average.

Universal Corporation, by the way, has a Short Term PowerRating of 8. We found that stocks with Short Term PowerRatings of 8 outperfomed the average stock by more than 8 to 1 after five days.

Tired of losing money trading breakouts and breakdowns? Our special, Free Report, “5 Secrets to Short Term Stock Trading” will show you some of the key strategies and attitudes that traders throughout history have used to determine the right time to buy and the right time to sell. Click here to get your free copy of “5 Secrets to Short Term Stock Trading”- or call us today at 888-484-8220.

David Penn is Senior Editor for TradingMarkets.com