What Is Buy a Bounce?
Buy a bounce is a trading strategy that focuses on buying a given security once the price of the asset falls toward an important level of support. Traders who "buy a bounce" attempt to profit from a short-term correction or "bounce" off of the identified support.
This can be compared with "buy the dip", which instead purchases securities after they have fallen significantly in price below a support level.
- Buy a bounce involves buying securities when they have reached a technical support level.
- The goal is to predict a bounce up from the support level in the near term.
- Enveloped and channels are useful technical tools to identify buy a bounce opportunities.
Understanding Buy a Bounce
Buy a bounce trading strategies are typically identified from technical analysis patterns. There are numerous patterns that can be used with various trading strategies that can also be deployed to profit from a buy a bounce strategy. When a security falls to a support level, a trader may purchase a position in anticipation of a near-term bounce.
Buy a bounce trading opportunities are identified when a security reaches its support trendline. Securities will generally trade within a specified price channel range for an extended period of time with the security’s price fluctuating within the resistance and support price ranges.
When a security’s price reaches the support line, traders can potentially use a buy a bounce strategy to profit from an expected increase of the low support level. Most traders will want to confirm a bounce off of a support level by using a combination of qualitative and quantitative technical indicators before entering a position.
Technical Indicators for Bounce Buying
Support, or a support level, refers to the price level that an asset does not fall below for a period of time. An asset's support level is created by buyers entering the market whenever the asset dips to a lower price. In technical analysis, the simple support level can be charted by drawing a line along the lowest lows for the time period being considered. The support line can be flat or slanted up or down with the overall price trend. Other technical indicators and charting techniques can be used to identify more advanced versions of support.
Many technical analysts use envelope channels as a key way to identify support lines for the buy a bounce strategies. Two of the most commonly used envelope channels include Bollinger Bands and Donchian Channels.
Bollinger Bands are drawn using a moving average center trendline. A moving average trendline is calculated as the average of the security’s closing price over a specified time period, typically 50 or 200 days. Once a moving average trendline is established, charting software will draw a resistance and support line two standard deviations above and below the midpoint moving average.
Donchian Channels are an envelope channel that is created using the high and low price of a security over a specified time frame. In a Donchian Channel, the resistance trendline is created from the highest daily price over a specified time frame. Adversely, the support channel is created from the lowest daily price over a specified time frame.
Example of a Buying a Bounce
Let's say your analysis says that XYZ stock will bounce at the $40 area. You believe this is the case because historically the stock has traded in a range of $40-$50. As the stock approaches $40, you put in a limit buy order to own shares at $40. Your goal is to profit from a quick bounce in the stock from a support area.
The most basic trade would include buying shares of the security to profit from a price increase. Traders can also use options to profit from a bounce. In such a scenario, a trader would want to buy an in-the-money (ITM) call that is expected to create greater profit as the price rises. As the price rises, the investor can exercise the call option at a strike price below the current price and benefit from the difference.