Updated: Aug 27, 2021
When we see a ball falling, we ‘see’ the floor and ‘expect’ the ball to bounce when it hits that floor. We don’t think anything of it since we ‘see’ the floor and ‘expect’ this behavior and therefore there is nothing to care about.
But, what if the floor was ‘invisible’ and ‘dynamic’? Would there still be a bounce? – YES, Would we be able to 'expect' this bounce?- NO, because the support (floor) is not known or visible to us unless in hindsight.
In the absense of 'visibility' there is 'lack of anticipation' and this gives rise to another question:
Can we tell whether the bounce will result in a still higher bounce or a deeper fall?- The answer to this question comes with many caveats but is possible with the use of tools and techniques.
In the world of Physics things are simpler because everything is specifically defined and constant, but in the world of psychology and its derivative- the stock market, everything is dynamic and contingent. In our world of the stock market, we refer to this bounce as 'Pullback'. While in Physics gravity works in one direction, in the stock market, this pull can be experienced in the form of 'throwback' also, the counterpart of 'Pullback'- a topic for another time.
Owing to the dynamic nature of ‘price floors’ (support levels ) and ‘price ceilings’(resistance levels), things are much harder to predict and comprehend but possible with the use of Technical Analysis tools.
With that in mind, let’s discuss the concept of ‘Pullbacks’ in more details and with few live examples.
As the name suggests, pullback happens when price falls below a support level and gets pulled back to the support it fell through. Usually observed after the breach of an important trendline or horizontal support.
Pullbacks are confusing and painful events. Confusing because participants who buy a stock close to trendline in hopes of it taking support at the trendline with a stoploss just below it lose as the stoploss gets triggered when the prices breaches the trendline. Now, when this breach in trendline sees a pullback to the trendline the long participants (now stopped out) painfully watch because they just saw the price surpass their stoploss level and are now considering whether or not they should go long on the stock again.
It is also painful for the counterpart short players because they saw the price breach the trendline and jumped at the opportunity to make money from short selling the stock. Their stoploss is likely to be the trendline which is now the resistance level for the stock by principle of fungibility.
Their stoplosses also get triggered in the pullback as pullbacks are sharp in nature and often times go slightly beyond the original breakout level, like a ball when dropped in water dips beyond the water surface brielfy but floats right back up.
Two recent examples of this PULLBACK are TATACOFFEE and STLTECH .
Both stocks are good long term buys but have been slaughtering short term players with supporting trendline breach and pullbacks.
The charts below show the observation towards the pullback in white drawings and further analysis in yellow drawings.
We will take a brief look at the chart of these two stocks to analyze our next move.
TATACOFFEE is at the resistance trendline on the weekly charts having rallied 400% from its COVID-19 lows of ~47.9.
The good news is the volume even near the top has been growing with rising price.
This is a bullish sign, but this leads to the question- When should we take position?
The hourly chart may have some answers for us.
As said above the white drawing showcase the phenomenon of pullback unfolding on the chart, while the yellow drawings show the analysis of evidences that hint at the future. We can see RSI was considerably below the level of 30 which mean the stock was oversold and in bearish overdrive. This behavior often leads to further weakness though it is often short lived. The pullback may result in resistance at the trendline level of Rs. 200 and price can continue to correct further down to retest its freshly forged low of Rs. 177 in which case the range of 170-177 would be a good entry zone.
Remember that TATACOFFEE is already 400% up from its last major low and surfing the resistance trending line on weekly chart. It may also continue its move higher up, breaking out above the resistance trendline. The volume profile we mentioned above supports this outcome. Right now, due to mixed signals it is best to wait for the price to confirm breakout above the level of 215 before taking any position.
So enter either between 170-177 else above 215.
On the weekly chart below, we observe the following:
The stock is enroute its resistance trendline at 600 which it has honored twice.- Bullish
Volume in the latest leg of the rally has been drying up against rallying price- Bearish
RSI is well above the overbought zone, indicating strong momentum- Bullish
For more clarity lets move to the hourly chart
Again, white drawings demonstrate the pullback phenomenon. The yellow drawings show the analysis.
Dashed yellow lines on the RSI and price show a positive divergence wherein price is showing lower low but RSI is showing higher low- Bullish
The pullback may be seen as a response to this bullish divergence, but the resistance from the breached trendline at 270 will be palpable if the price begins to rally higher.
245- the recent price low is a good support for STLTECH and the stock may retest the same before resuming the rally to Rs. 600.
All in all we sense a strong bullsh sentiment for the target of 600 but weakness in shortterm. A better entry level can be sought close to 245, 9-10% lower than the CMP 272.
To conclude, PULLBACKS are nasty, hard to predict, friendly with neither the bulls nor bears. They invoke fear and confusion in participants and can only be waited out. They are phantom moves which are reactionary in nature. The best way to tackle them is with patience and by staying loyal to the trade strategy one started out with. Reacting to pullbacks and making buy or sell decisions are faulty trade practice which can do more damage than good. They can be braved by using additional tools, techniques and indicators as demonstrated on TATACOFFEE and STLTECH.
We will follow up this analysis after few weeks to see how things unfolded and deliver a video on the learning. Follow us on Youtube and hit the bell icon so you dont miss an update.
For any queries related to stock, commoditie, indices or cryptocurrency, please reach out to me on 9836452228. You can raise stock query requests here.
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