October 29, 2007 at 7:10 am | | Comments 1

How Pullbacks Help Build New Chart Patterns

The recent market pullback may or may not be finished, but it brings up an important subject which is why pullbacks within trends are good and healthy. Whether we’re talking about an uptrend like the one the market is currently in or a downtrend like we’ve seen before, prices don’t move nonstop in the same direction without taking some breathers along the way. Call them pullbacks or retracements or dips or whatever, but the fact remains that contra-trend moves certainly help to produce new chart patterns for potential new entries as the trend continues.

In the current market uptrend, pullbacks help to shake up the charts and allow them to reset. This creates new base-building opportunities for stocks which had previously gotten too extended to chase. As a stock goes parabolic and keeps climbing higher without a rest or dip, new buys become very high-risk.

I never want to buy a downtrending stock, but I do get excited when I see pullbacks come along. Even just 1 or 2 bars of downside within an uptrend can lay the foundation for a new base or chart pattern to build. Let’s look at an example and I’ll show you what I mean (click the thumbnails to see the full-size images).

The Uptrend

HANS has been trending higher at a rapid pace, hardly slowing down for new entries. Here’s a look at the run:

(Click for full-size image, courtesy of TeleChart)

The Pullback

A week ago, HANS sold off hard with a pair of downside spikes coming right off the highs, shaking up the overall appearance of the chart and signaling a temporary end to the nonstop run. Although traders who held the stock during the decline no doubt felt some pain, this kind of shakeup is exactly what can bring opportunity. The pullback itself doesn’t make a new base, but it does create the framework for a new base to mature from. Here’s a look at HANS post-pullback:

(Click for full-size image, courtesy of TeleChart)

The Rebuilding Phase

Since the dip, HANS has bounced again and currently is back near the highs. This allows us to draw two trend lines, one along the recent lows and the other along the recent highs, creating a bullish ascending triangle pattern. This hypothetical example shown below needs more time to mature and really develop fully before it would be a trade I’d take, but I’ve drawn in yellow bars to show how price might cooperate in order to allow this pattern to be complete. Some additional horizontal price action within the blue triangle would create a solid base from which a new advance could build on, while simultaneously providing a tighter natural stop-loss level as the triangle narrows. Here’s a look at one way in which this pattern might progress:

(Click for full-size image, courtesy of TeleChart)

I like the HANS setup and would consider taking it for a trade if it develops the way I’ve hypothesized, but the example should help to show you the kinds of things to look for after seeing a dip in the market or a particular stock which you’ve noticed climbing nonstop. The initial dip sets the base-building process in motion, and that’s always a good thing. Pullbacks should be a welcomed sight for any technical trader, and now you have one example of something to watch for in the charts the next time a dip comes along.

Trade well today!

Jeff White
President, The Stock Bandit, Inc.
Swing Trading & Day Trading Service

[tags]Stock Market, Day Trading, Stock Trading, Investing, Swing Trading[/tags]

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