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Buying into the Pullback

Posted on February 10, 2009 by Adam

Some pullback, huh?

With the dow down 400 points and the VIX spiking, I have to admit I feel a little bit more worried about the state of our economy. My opinion is that we ultimately have more deleveraging to do before this market can reset itself.

Then why in the world am I looking to buy today?

Have a look at this chart:

The S&P continues to put in higher lows on the S&P, having me pretty bullish in terms of swing trading.

This is a point and figure chart of the S&P 500. For those of you who are new to Point and Figure charting, I am looking at putting together a brief, live webinar where I can do some teaching, because they really are a great tool. If you’ve never seen one of these before, you read them from left to right, and each column of O’s represents a period of decreasing prices. Each column of X’s represents rising prices. When a column of X’s switches to a column of O’s we call it a reversal.

The red line I have drawn at the bottom of the chart shows a series of higher lows, represented by columns of O’s reversing into columns of X’s. We have continued to do that for about a month now, and each successive low has been higher than the previous.

To me, that screams out: rising demand. Buyers are insistent and continue to step in and support prices each time.

Today we saw prices reverse out of a column of X’s and into a column of O’s. Now look at how prices have approached that red line today (The red O’s are O’s that are new today). If the pattern continues, then we will see higher prices in the short term, setting up the next swing in the market.

What we have setting up is a low risk opportunity to get bullish. Buying into this pullback may only work out 50% of the time, but I know to exit any long trades if the S&P goes on a point and figure sell signal at 815, which would break the pattern of higher lows.

I’m taking small nibbles today towards the close on a long position in technology, which has shown outstanding relative strength these last weeks. I’m not betting the farm here - like I said, it may only work 50% of the time. However, I will gladly take such a small risk to catch the potential upside we could see if the market decides to rally.

If we do get below S&P 815, I won’t hesitate to add bearish positions.

Just some thoughts to munch on…

Happy Trading!

Adam