Thursday, July 05, 2007

What if your pullback play goes against the overall market?

I recevied the following question from a reader. It's a tough one to answer, as I have no hard and fast rule on the topic.

I wanted to know if you will enter pullbacks that look good even if the market was strong during the pullback? Basically say the DOW or Nas had a nice 2 day rally, or even 1 good day. But you run your scans and notice stock ABC had a pullback during those 2 days. Would you consider buying that stock?

That is a tough question Aaron. I have no hard and fast rule on this, although it is something that comes up frequently. I tend to pay more attention to the accumulation pattern of the stock and it's sector, rather than the very short term market itself. Lagging for a couple of days is not all that significant. If this is a continuing pattern, then of course, there is something wrong with the stock.

I also like to look at the sector. Maybe the sector had a run up while the market was dead, which caused profit taking while the rest of the market surged. I've noticed this many times with energy and steel.

If there looks to be solid accumulation, the pullback is on low volume, it's a good setup, it's not lagging the sector, there is adequate support *and* the reward to risk ratio is good, I will consider the trade. I may protect myself by going with a smaller position size. Whenever I am in doubt, I go with a smaller position size and closely manage risk. While I am loose with my entries, I am precise with my risk parameters.

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