Stocks Pulling Back to a Buy-Zone

By Cory Mitchell | June 16, 2014 AAA

There's an adage which claims old resistance becomes new support. That's only partially true. For the price to likely (but not always) find support at an old resistance level, the resistance level should have been tested at least twice (preferably three or more times) and the breakout above that resistance should be aggressive and fairly extensive. "Fairly extensive" is subjective, but means the price should move far enough above the old resistance zone to rule out a false breakout. When the price tests a resistance zone two (preferably more) times, and then has a strong break above that area, when the price pulls back to that area it is more likely to act as support. Such is the case with these four stocks. 

Throughout March, April and early May, American Airlines (NYSE:AAL) met a resistance zone between $38 and $40; it tested the area about six times before eventually breaking above it in June. Since the resistance area was about $2 in height, the breakout above the resistance should also be at least $2 to rule out the possibility the price rise was just a false breakout. On June 9, the price reached $44.43, $4.43 above the former resistance area, indicating the breakout is legitimate. A pullback to, or into, the former resistance area ($40 to $38) presents a buying opportunity. Target is $45.50 with a stop below $37.50.

Throughout March, April and early May, American Airlines (NYSE:AAL)

Capital One Financial (NYSE:COF) tested a resistance area between $78.49 and $77.91 three times since the start of 2014. A breakout in June saw the price rally to $82.32, successfully clearing the resistance and indicating the the move higher isn't a false breakout. How far the price will pull back is unknown, but the buy-zone is between $79.50 and $78, with a stop below $77.50. The upside target is $85 to $86.50.

Capital One Financial (NYSE:COF) tested a resistance area between $78.49 and $77.91 three times since the start of 2014.

Atmel (Nasdaq:ATML) peaked three times in early 2014 between $8.91 and $8.76 before breaking higher in June. The breakout was aggressive and substantial enough to indicate it wasn't a false breakout. Buying on a pullback to the former resistance area, or slightly above it, is one option. Given the price has had a near vertical run since the may low at $7.47, a deeper pullback is possible. While it may not occur, waiting for a pullback to the $8.50 to $8.25 provides a better risk reward. Place a stop loss below $8. The target is between $9.25 and $9.50 since the stock has a tendency to breakout then range again; getting out near the top of what is likely to be another range ($9.50 area) is the prudent play.

Atmel (Nasdaq:ATML) peaked three times in early 2014 between $8.91 and $8.76 before breaking higher in June.

Anadarko Petroleum (NYSE:APC) is moving aggressively higher after testing the $103.92 to $104.84 resistance zone three times in April and May. In June, the stock broke aggressively higher, and it could be some time before a sizable pullback occurs. Based on the old resistance zone, a pullback between $105 to $104 presents a buying opportunity. Stop loss is placed below $102, or $100 to provide a bit more room on longer-term trades. Following the pullback the target is above $110.

Anadarko Petroleum (NYSE:APC) is moving aggressively higher after testing the $103.92 to $104.84 resistance zone three times in April and May.

The Bottom Line

For old resistance to become new support, the resistance area should be tested multiple times before a breakout occurs. The breakout should be large enough to rule out a false breakout. When the price pulls back to, or into, the former resistance area, it presents a buying opportunity. This pullback is caused by traders selling their position to lock in a small profit from the prior breakout. Once that selling ceases, the uptrend is likely to continue. The same process can be applied to different time frames to suite your trading style and time frame. Nothing works all the time, but by making sure the resistance area and breakout correspond to the aforementioned guidelines, old resistance is more likely to become new support. 

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