These stocks are in uptrends and have recently pulled back. The pullbacks present a potential opportunity for capitalizing on the next wave of the uptrend. Trending stocks in a pullback phase can be found by screening for stocks that are above a significant moving average, such as the 200-day, and that have pulled back to the 40 region on the RSI indicator. Such a screen is just the starting point. Traders should then make sure the price action confirms the stock is in an uptrend— higher swing highs and higher swing lows—and that the current pullback doesn't violate the uptrend (isn't making a lower swing low, for example).

Xylem Inc. (XYL) has been in an uptrend for more than a year and hit a high of $54.99 in November. Since then, the stock has been pulling back with the RSI currently near 40 (36.9). The pullback has also retraced approximately 75% of the November advance. During a trend, 60% to 70% retracements are quite common, and several such pullbacks have occurred in this stock over the last year. Therefore, with the stock experiencing a good sized pullback based on retracement percentages and the RSI, long trades can be considered.

One option is to buy when the RSI moves back above 40. A stop loss goes below the recent low that occurred just before entry. Since this is an uptrend, the price is expected to move back to $54.99 or above. Consider a target in this region. Even a target near $55 presents a 2.5:1 or 3:1 reward for the risk (estimated, since the exact entry point and stop loss haven't been solidified yet). It is best not to rely on indicators in isolation. Continue to view the price action. The trade should only be taken if the selling levels off and the price starts rising (moving above the highs of the last two or three trading sessions) in conjunction with the RSI moving up.

XYL pullback potential buying opportunity in long-term uptrend

RSP Permian, Inc. (RSPP) had traded mostly sideways throughout 2014 and 2015 and then had a strong breakout to the upside in 2016. The upside movement continues to play out with the stock hitting a high of $46.92 on Jan. 5. Since August, pullbacks have retraced more than 60% of the last major up-wave. Therefore, it may be best to wait for this pullback to reach the 60% retracement level ($39.73), or below, before considering a buy. Once the price moves closer to $39.73, a rally above 40 on the RSI could set up a potential buy trigger. An alternative entry technique is to wait for the price to move below $39.73, preferably consolidate, and then buy when the price moves above the high of the previous two to three trading sessions. A stop loss is placed below the most recent low (determined at the time of entry), and a target is placed near or above the recent high of $46.92.

The Bottom Line

Use indicators to find potential trading opportunities. Moving averages, an RSI or retracement levels (%) are all possible ways to do this. Ideally, they shouldn't be relied on in isolation. Look at the price action; verify that a trend is present and that the pullback is near what is typically an exhaustion level for that stock (estimated based on previous RSI readings and percentage retracements). A move higher in the RSI can be used to trigger a buy signal but should be confirmed by the price making a multi-day high as well. Pullbacks may continue, or the trend can reverse at any time, therefore, utilize a stop loss and only risk a small percentage of account capital on any single trade.

Disclosure: The author doesn't have positions in the stocks mentioned.