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Why You Should Buy Strong Stocks on Retraces
02/18/2015 7:00 am EST
When the technical and fundamental pictures remain positive but no one is willing to buy, it's time to step in, writes LA Little on Minyanville.com.
Markets can travel in three directions and for varying lengths of time. They either go up or down, or they drift around in some defined sideways range. How one approaches each market is different. In an up or down trend, my extensive research has shown that breakouts are playable in certain cases, but the majority of the time, retraces are the higher-probability trade.
For sideways markets it's all about fading the edges of the range. Whether you trade both sides or just one side depends on the set-up. I talk about all of this in my latest book, Trend Trading Set-Ups so if you have a real interest you can check that resource out. Being able to recognize which type of market you are in is the key, and understanding when it has ended is just as important. So what kind of market are we in now?
On the short-term time frame (three months), the market type is a range-bound market, and it is likely to remain that way for a while longer. When I say a while, I am speaking of two or three weeks on the short-term time frame. Here's a chart of the S&P 500 (SPX) showing the multiple ranges that have formed.
In this chart there are three distinct ranges currently-almost like floors stacked one on top of the other. We are on the lowest level, and several attempts over the past week of trading to regain the next higher range have failed. In fact, Tuesday's failure was across all indices and many sectors. That's not a good sign.
Despite the weakness, there are many stocks that just keep rolling along. In my last article I provided a pointer to stocks with relative strength. Many of those are still on the relative strength list: names like Facebook (FB), which cannot even decline for more than a day in a weak market, or even Apple (AAPL).
Stocks with relative strength are stocks that you buy into on retraces caused not by the stock itself, but by the weakness in the overall indices. We just witnessed flash PMI index numbers around the world that almost universally surprised to the upside. June was the first month this year that exhibited weakness, which was more than recovered in July and now there's another soft patch. Everyone says they will buy the pullback, but when it arrives, nobody wants anything to do with it. Folks, this is the retrace. You have to pick at stocks when others are unwilling and the technical and fundamental picture remains positive.
Sure, we can get more selling in the indices. Looking at the chart above, the S&P 500 could easily trade back into its anchored support zones. In fact, it is at one right now and that is where you have to take on some stock, in my opinion.
So once more I emphasize that, contrary to most, I believe you have to be buying into the retraces, not fearing and worrying about them. They are opportunities to add exposure in companies that are exhibiting relative strength and are simply being brought lower by the misfortunes of general market fears pertaining to Federal Reserve tapering and Syrian strikes.
By LA Little, Contributor, Minyanville.com
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