Weekly Update: How to Buy Stocks on Pullbacks
Good evening, and welcome to this week’s edition of Stealth Trades!
The bull market rages on. The Dow, Nasdaq and S&P 500 indexes made new all-time highs for the second week in a row.
We have been preparing members for this move for months. If you followed our advice, you are fully invested and enjoying the fruits of your diligence.
But if you still have cash waiting to be deployed, the best way to do so is to buy on pullbacks. And in this week’s newsletter, I want to give you a crash course on how to do that.
Pullback buying is different from buying a breakout. What you want to find is a key level that is likely to support prices where buyers are prone to step in.
When the S&P 500 set up in a breakout pattern last year, it was actually less risky to buy a new high since this meant the consolidation was over (see chart below).
But today stocks are making new highs. So, you’ll want to take a different approach.
There are two places to buy pullbacks – moving averages and support levels. Let’s start with moving averages since this is the simplest method.
Stocks that trend well, especially large cap stocks, tend to find support at one of their key moving averages on the way up.
The two I watch are the 21-day exponential and 50-day simple moving average.
For very strong stocks – those rising 15-20% per month – I like to buy on pullbacks to the 21-day. Below is a daily chart of Zscaler (ZS), a leading cloud-based cybersecurity stock.
Notice how the 21-day EMA (blue line on chart) “supports” the stock price on the way up. Any touch of this line is typically a good place to buy during a strong trend.
We saw the same thing with CrowdStrike (CRWD) – another leading software stock.
For slower-moving stocks – those going up 5-10% per month – I like to watch for pullbacks to the 50-day moving average.
This is a heavily defended level in Stage 2 uptrends where we typically see institutional buying.
This is Microsoft (MSFT) during the powerful run it made in the 2nd quarter last year:
Notice how support is found at the 50-day moving average (red line) each time it is hit.
We can see the same thing in the current rally taking place in Microsoft (MSFT) today:
For large, blue-chip stocks, the 50-day moving average is by far my favorite place to buy during trends. If a stock cannot hold its 50-day, it is likely in trouble and not experiencing the kind of institutional buying that leads to large moves.
So that’s the quick and easy way. Look for leading stocks in strong trends and buy on pullbacks to the 21 or 50-day moving average depending on how rapidly the price is rising.
If you are unsure which to use, just split the difference and try to buy between the two. You don’t need to risk more than about 15%. When bought at proper support, the stock should reverse soon and resume its uptrend.
The other place to buy pullbacks is at previous support and resistance zones. This works on both individual stocks and indexes.
Below is a weekly chart of the S&P 500 index:
Notice the initial breakout in April of last year that we discussed earlier. This was a resistance level the market could not get above.
The rally that followed handed us big gains before running out steam and pulling back. Where it stopped, however, was not a coincidence.
What was resistance often becomes support, and this became a powerful support level where investors could buy the pullback. You may remember this setup when I pointed it out in October – the week before this huge rally began.
You will find this same approach useful for individual stocks. Let’s take Salesforce (CRM) for example…
Here you can see a clean breakout entry from May of last year at the $200 level.
Now look what has happened since:
This $200 resistance level then served as support and created three great buying opportunities before the next rally higher.
Previous highs or lows can also serve as future pullback buy areas. In the daily chart of Microsoft (MSFT) below, we see the all-time high it made back in July.
Six months later, after the stock had surpassed this level, it became a new area of support and a great place to buy on a pullback.
This time, it coincided with the 21 and 50-day moving averages.
Three levels of support at the same price on a market-leading stock during a bull market? That’s a buy signal all day long.
These simple techniques will help you buy pullbacks at areas with the least amount of risk and the greatest chance of a quick bounce higher.
There are other things to watch for to make this approach even more effective…
One trick is to buy low volume pullbacks after high-volume moves higher. This is another clue that selling is light and institutions are still in control.
But we can dive into that another day.
Best wishes for your trading,
