Have you ever looked at a stock chart, where the price is sitting inside a flat base for many days or weeks? Maybe you expected when the price finally breaks out of the base, the move will be explosive. You put the stock on your watch list, but for one reason or another you missed the day it takes off ... You notice it after a few days, and it's done exactly what you expected - 5-10% move up in just a day or two on huge volume. Unfortunately you were not in it!
Missing great breakouts can be very frustrating, but not all is lost. In this strategy I show when to buy recent breakouts on a pullback. But buyer beware ! Not all breakouts are good, and not all pullbacks will lead to the continuation of the move up.
First of all I like to give myself the best odds that the breakout will turn into a valid and lasting uptrend. I like stocks that break out of a flat base, built over multiple days or even several weeks. Experience shows that the longer the price builds a base, the longer the following uptrend will continue. Also it is important that when the breakout occurs, it happens on enormous volume and it decisively clears the resistance levels. As a rule of thumb, I want to see at least 4-5 times the average daily volume and the price 1-2% above the resistance for me to know the move is real. It's best to get involved at this level, but if missed, I wait to see if the stock will have a proper pullback.
A breakout stock will usually keep running ever higher for several days on big volume. The first day of the pullback will often be on heavy volume as well, often almost as much as the last up day just preceding it. This is the effect of the swing and momentum traders taking profits. However as the stock continues to step down over the next several days, volume should decrease and the price range of the days during the pullback should be smaller than the range of the days on the way up. Often a stock may come almost all the way back to the old resistance and that is OK. If it took the stock just 2-3 big volume, large advance days to reach its recent high, it should take it 5-6 lesser volume, small decline days to come back to or near the old resistance.
As the pullback goes lower and lower, volume should dry up as everybody who wanted to sell is already out. Now we wait for new buyers to come in. This is the renewal of the uptrend. We inspect carefully the first day of the renewed rally. There could be up days during a pullback, but we are looking for a strong day up on above average volume. That day does not have to be as impressive as the first days of the breakout, but as a minimum it needs to have more range and more volume than the previous down day. If the day's volume is mediocre and/or the move up is very small, then this is just an up day, it does not signify a renewal of the uptrend.
Below is the perfect example that illustrates exactly what I'm looking for. Pharmasset, Inc. (VRUS) built a flat base during February and the beginning of March. When it finally broke through on March 7, the volume was enormous and the advance that day $10 i.e. almost 20% (arrow A). It reached $70 before the pullback began. Notice that the daily candles during the pullback were small and their corresponding volume was average or below average. There was one up day, but its volume and range were so small, the pullback was obviously still in effect. Then on March 21, we had a decent up day on above average volume (arrow B). This was the signal the uptrend was resuming and it did not disappoint. The price has continued higher since.
Below are three stocks I am watching and waiting to buy on a pullback if everything looks right. All three had good breakouts and have been going up for a few days. If they act similar to VRUS when they come back, I will be buying.
Lululemon (NASDAQ:LULU) formed a base throughout March and recently broke out on March 28 (see arrow). Note the large advance of $5 of the breakout day, and its major volume. LULU may be starting its pullback as of today (March 31).
Wabtec (NYSE:WAB) broke out from a Cup-with-Handle formation on March 28. It gapped pre-market and closed at $66 that day (a gain of almost $7). Again note the huge volume of the breakout day, indicating the validity of the move.
Wolverine (NASDAQ:WBKC) broke out from its base on March 22 (See arrow). The penetration above resistance was small and the volume that day although above average was not spectacular. So I was suspicious of the breakout until it was confirmed by another big move up with big volume on March 24. Seems the pullback already started on the 30th (red candle). It is encouraging that although the decline was decent, the volume was meager. Today March 31 was an up day, but volume was even worse, so WBKC will likely see lower levels before the uptrend resumes in earnest.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in WAB, LULU over the next 72 hours. No position in WBKC, but may initiate a long position.