How to Trade a Short-Term Bounce in an Oversold Stock
After an ugly stock market correction, beaten-down stocks in sharp downtrends can offer profitable opportunities for short-term traders. Here’s a simple method for knowing when to buy with relatively low-risk.
When overall market conditions are strong, we focus on trading explosive growth stocks that are within 20% of their 52-week highs and with massive quarterly earnings or sales growth.
But when the market is in correction mode (major indices below their 20 and 50-day MAs), we don’t mind protecting profits and keeping the Wagner Daily portfolio mostly in cash.
Additionally, we also take on a few short positions as they develop.
However, when the market is extended to the downside and finally begins to bounce, what is our game plan?
When the stock market bounces from highly oversold levels, most beaten-down stocks are already extended well below their 20-day exponential moving averages.
After a nasty plunge, the short side no longer provides a positive risk/reward ratio for new short entries
As for long positions, those that showed relative strength during the selloff tend to lag the market when it reverses higher–at least until there is a true bottom in place.
What to buy when stocks are extended to the downside?
If you’re a more active trader and don’t mind buying off the lows, then beaten down stocks (as discussed above) are some of the best short-term trades–when the major indices are in bounce mode, after an ugly sell-off.
The Uglier, The Better!
The daily charts of GoodRX ($GDRX) provide an excellent, recent example of what we look for when buying off the lows.
The decline in the first chart below is nasty, as it caused all moving averages to become stacked to the downside (200-MA, 50-MA, 20-MA, 10-MA).
This is the exact opposite of what we look for in 99% of the long setups we enter in our swing trading report.
However, in this case, we are only looking for a short-term pop in an oversold stock–and THIS is exactly the type of chart we are looking for!
When is the right time to buy? No falling knives!
First of all, we are NOT interested in catching a falling knife or bottom fishing.
Rather, we wait for short-term price action to show a bit of bullish momentum first.
After a sharp thrust off the lows, the first pause in the rally that shows constructive, tight action over 2-3 days is our signal that it may be time to buy.
The price can pull back in a bit, but should not retrace too much of the last advance.
It should also hold above the 10-day exponential moving average.
The entry point in these type of swing trade setups can be above a prior day’s high or hourly downtrend line:
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