If you have been involved in the markets for more than a short while, you have probably heard the expression “The Trend is Your Friend.” In fact, it is so common that it almost seems trite. Maybe it is, but that doesn’t mean it’s not true. Simply put, over the years many traders have concluded that it is generally a higher probability strategy to trade with the current flow of money, rather than paddle upstream.
Let’s say, then, that you too decide to swim with the current. Is there a strategy that lets you dive in but decreases the chance of immediately drowning? The answer is a resounding “yes!” Welcome to “The Pullback”
As the name suggests, a pullback is a short term move in the opposite direction of the longer term trend. It can offer an opportunity to join the trend without chasing the stock. But trading pullbacks can be tricky. Let me share with you some hard won insights about entering and exiting this type of trade.
The first one is trying to figure out if a pullback is simply a pullback and not the beginning a trend reversal. You never know for sure, but here are a few clues I look for.
First, I’ll look at the volume pattern. Has there been less volume in the pullback than in the previous up-leg? If not, the sellers might be gaining power and I’ll generally pass.
Next, I’ll double check to make sure that earnings or other anticipated significant announcements are not coming out over the next week or so. I don’t want to take the risk of the stock gapping down right after I enter.
Then finally, and perhaps most importantly I’ll take a look at the last trading day. Has the stock pulled back to a price that buyers might find attractive? This could be a previous low, an uptrend line or a supporting moving average. And now consider this: what does a retracing stock have to do if it is going to back up? Doesn’t it have to trade above the high of the previous day? Sure, it could trade through that high and then reverse, but if it is going to back up then it has to trade through that previous high. Waiting for that simple confirmatory signal has saved me more times than I can count.
Now let’s discuss actually entering the trade. Naturally, I want to enter as soon as yesterday’s high is exceeded. But since I can’t always look at the market constantly during the day, I’ll place an automatic entry order the night before. I generally use what’s called a stop limit order. Let me explain why. Let’s assume the previous high was 37.50 and I want to buy if the stock pushes above 37.60. I can’t use a limit order to buy at 37.60 because I could get filled at 37.60 or lower, and that is not what I want. I only want to enter if the stock is breaking up through 37.60. I could use a buy stop at 37.60, but since regular stop orders turn into market orders when triggered, what happens if the stock gaps up to 42 on the open due to overnight news? With a stop order I would buy at 42. Again this is not want I want. So instead I’ll use a stop limit.
Let’s say, then, that you too decide to swim with the current. Is there a strategy that lets you dive in but decreases the chance of immediately drowning? The answer is a resounding “yes!” Welcome to “The Pullback”
As the name suggests, a pullback is a short term move in the opposite direction of the longer term trend. It can offer an opportunity to join the trend without chasing the stock. But trading pullbacks can be tricky. Let me share with you some hard won insights about entering and exiting this type of trade.
The first one is trying to figure out if a pullback is simply a pullback and not the beginning a trend reversal. You never know for sure, but here are a few clues I look for.
First, I’ll look at the volume pattern. Has there been less volume in the pullback than in the previous up-leg? If not, the sellers might be gaining power and I’ll generally pass.
Next, I’ll double check to make sure that earnings or other anticipated significant announcements are not coming out over the next week or so. I don’t want to take the risk of the stock gapping down right after I enter.
Then finally, and perhaps most importantly I’ll take a look at the last trading day. Has the stock pulled back to a price that buyers might find attractive? This could be a previous low, an uptrend line or a supporting moving average. And now consider this: what does a retracing stock have to do if it is going to back up? Doesn’t it have to trade above the high of the previous day? Sure, it could trade through that high and then reverse, but if it is going to back up then it has to trade through that previous high. Waiting for that simple confirmatory signal has saved me more times than I can count.
Now let’s discuss actually entering the trade. Naturally, I want to enter as soon as yesterday’s high is exceeded. But since I can’t always look at the market constantly during the day, I’ll place an automatic entry order the night before. I generally use what’s called a stop limit order. Let me explain why. Let’s assume the previous high was 37.50 and I want to buy if the stock pushes above 37.60. I can’t use a limit order to buy at 37.60 because I could get filled at 37.60 or lower, and that is not what I want. I only want to enter if the stock is breaking up through 37.60. I could use a buy stop at 37.60, but since regular stop orders turn into market orders when triggered, what happens if the stock gaps up to 42 on the open due to overnight news? With a stop order I would buy at 42. Again this is not want I want. So instead I’ll use a stop limit.
