How to Buy on a Pullback

05/22/2009 12:01 am EST

Focus: STRATEGIES

Deron Wagner

Founder and Head Portfolio Manager, Morpheus Trading Group

Regardless of whether we buy a breakout above a range or enter a trade on a pullback, it certainly helps to have a few different ways to climb aboard a strong trend. Many new breakout traders tend to get too down on themselves when they miss an explosive breakout. It's easy to do when sitting in front of the monitor and the stock you wanted to buy is ripping higher, up five to ten percent above your buy point. But rather than crying over spilled milk, we view the breakout as a new opportunity to hop onboard a strong trend that has proven itself. Once we locate a breakout from scanning, we closely monitor the action on our daily watch lists for a low-risk buy point off support.

Below are two different setups that can be used to enter a strong uptrend:

1) Buying a pullback to the 20-day exponential moving average:

chart

After breaking about above $42.00 in mid-March, QSII twice pulled back to the 20-day EMA before resuming the uptrend. The next pullback to the 20-day EMA, around $50.00 - $51.00, is a potential entry point.

2) Buying a pullback to a prior resistance level in a strong uptrend:

chart

Basic technical analysis books teach that once a stock breaks through a resistance level, that resistance should then become the new support. On the NFLX chart above, notice how each breakout successfully defended the prior resistance level on a pullback.

The key to applying both of these simple entry techniques is stock selection. Finding a stock that is in a strong uptrend, preferably at its highs, or within ten percent of a 52-week high, is the optimal situation. Once a trader locates a high-quality pullback setup, he or she can then determine how aggressive to be with the entry point.

Aggressive traders may want to establish a small position at support, and then add additional shares as the price action begins to reverse higher. Some may feel more comfortable waiting for a break of the hourly downtrend line after the pullback as confirmation of the strong uptrend resuming.

By Deron Wagner of Morpheus Trading Group

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