Here’s what I look for in an ideal pullback setup
Price action was quite good today. The indices were strongly
green across the board. Breadth was also quite impressive. Volume wasn’t.
Today’s rally basically puts us back were we were after Wednesday’s rally.
Someone recently asked me what it would take for me to start buying. That’s
easy…buying opportunities in individual stocks. I am not seeing any fast growing
companies that are completing basing formations and breaking higher. It’ll take
more than that to convince me a new bull-leg is underway, but that’s all I need
to start dipping my toe in the water. So far…not much.
I’ve received several questions about shorting lately. Specifically, what types
of things do I look for in a short candidate and what types of patterns do I
like to trade? In general I typically look for stocks with low Relative Strength
and Earnings Ratings. I like to see growth significantly slowing or the company
to be in the red for an ideal short candidate. I then look to trade them as they
break down from consolidation patterns. Patterns like inverse cup & handles,
flat bases, and head & shoulders.
The current market is a bit tricky for trading breakdowns, though. Volatility is
high and trading has been whippy. Breakouts and breakdowns are both capable of
being whipsawed in a choppy, uncertain, environment. In an environment like
this, therefore, I am more apt to focus on pullbacks. This allows me to keep my
stops tighter and better control risk.
When trading pullbacks, to help put the odds in my favor, I always look for
pullbacks to areas of potential resistance (downtrend support). Types of
resistance I look for include price resistance (former swing highs), moving
averages, trendlines, and Fibonacci levels. In general, the more kinds of
resistance I can find in a particular area, the more confident I am in taking
the trade. A pullback to a price support that coincides with a moving average
and a Fib level stands a better chance than just a pullback to a price support.
Resistance levels are places where many traders will look to sell, either long
or short. The more kinds of resistance you have near a particular level, the
more people will be looking to trade it. If one person uses Fib levels and
another trendlines, a pullback to an area where they both coincide will have
both traders selling into it, rather than just one. This increases the chances
of the resistance actually working and the price moving back down from this
area.
With resistance levels near your entry point, you’re provided with a nearby
natural stop level. Since reward on short trades is lower than long trades
(can’t make more than 100%), risk needs to be managed tighter. This is one way
to assure your stops are tight.
Best of luck with your trading,
Rob
For those who may be looking to expand their
knowledge beyond just market timing, my
Hanna ETF Money Flow System utilizes the VIX in generating trading
signals for spread trades.
Rob Hanna is the principal of a money
management firm located in Massachusetts. He has spent the last several years
developing and refining methods for trading in stocks across multiple time
frames. He selects stocks using both fundamental and technical criteria, and
then trades them using technical analysis techniques.