Buying pullbacks after strong rallies offer excellent opportunities to get on board active uptrends at lower prices, but the strategy requires more technical skill than most market players realize. It’s also dangerous because catching falling knives can incur steep losses without strong risk management that identifies prices and times when trades fail and need to be abandoned.
Use cross-verification to identify low-risk pullback levels. This technique scans for narrow alignment between technical elements where buying signals in different trading systems go off at the same time. Trendlines, Fibonacci retracements and moving averages mark three types of converging data, but the list includes many less obvious elements, including gaps, opening prints after breakouts and prior highs.
The following candidates feature well-organized price action that’s hit overbought levels, giving way to pullbacks that are still in progress. Daily and weekly Stochastics set to 5-3-3 assist entries into these falling knives, identifying when they reach oversold levels that favor strong bounces. Once signals go off, downshift into 60-minute charts to localize entry prices through small scale reversal and basing patterns.
J2 Global Inc. (JCOM) topped out at $84.15 in December 2015 and entered an intermediate correction that found support in the mid-50s in March 2016. It spent the rest of the year in recovery mode, finally reaching the prior high in December. A February 2017 breakout tagged $90.88 before reversing into a multi-day pullback that dropped the stock more than 8-points in just three days.
The decline has settled on top of the 50-day EMA and support from the prior trading range (red line) while the daily Stochastics oscillator has hit the oversold level. The weekly indicator remains in active sell mode, requiring a few more sessions to reach an oversold technical reading, predicting additional basing action followed by a bounce that could confirm the breakout.
Ferroglobe PLC (GSM) fell to an all-time low at $6.90 in February 2016 and turned higher in a strong bounce that stalled above $10 in March. Eight months of testing at that resistance level gave way to a November breakout that reached the 200-day EMA a few weeks later. A selloff starting at that level got bought aggressively in late January, yielding a breakout to $12.53, followed by a pullback that’s now entered its third week.
The two-legged decline may be headed for $11.00 where the 50-day EMA, 50% retracement level and February gap have narrowly aligned. Daily Stochastics is coming off the oversold level while the weekly reading remains in a strong buy cycle, which makes sense after the vertical rally wave. A blind entry at 11 with a tight stop loss could work with this configuration as well as waiting for a bounce to close back above the broken Feb. 9 low (red line).
Delek US Holdings Inc. (DK) tested the 2013 high at $41.47 in 2015 and sold off in a nasty downtrend that bottomed out in the low teens in June 2016. The subsequent recovery has unfolded in two strong rally waves that topped out at $26.06 at the start 2017. The stock has been pulling back for the last 6-weeks and is now basing just below the 50-day EMA.
Weekly Stochastics crossed higher from the oversold level last week, but the stock won’t issue a traditional buying signal until it rallies off support. Pullback traders don’t need to wait for that event as long as they’re willing to play a lower time frame pattern while utilizing a tight stop to reduce risk. The 60-minute chart offers valuable insight in this setup, completing a rounded basing pattern with resistance at $23.
The Bottom Line
Market dynamics support second chance trade entries into strong uptrends through pullbacks and buy the dip strategies that predict where selling pressure will come to an end. Strong technical skills are needed to identify these low-risk levels, while strong risk management skills are needed to reduce risk if proven wrong.
<Disclosure: the author held no positions in the aforementioned stocks at the time of publication.>