From the desk of Tom Bruni @BruniCharting
We always hear the phrases “fading strength” or “selling into strength” from market participants, but what does that mean from a practical standpoint? How do you know what to sell? When do you sell?
In light of those questions, this week’s “Chart of the Week” is going to help provide some context around the types of characteristics we look for when choosing stocks to fade.
Pinnacle Financial Partners is a great example of a chart we love.
Looking at the daily chart we can see the stock below a downward sloping 200-day moving average with momentum in a bearish range. In October prices broke below a three-year support level, immediately fell another 15%, and has now retraced back to this former support level.
Click on chart to enlarge view.
What this chart suggests is that we want to be fading any and all strength back toward that former support level of 58.50, expecting the stock to retest its October lows and eventually break them. Given the action earlier in the week, we’ve already seen confirmation of sellers coming in to defend that level, pushing the stock down roughly 8.5% in 2 days.
So how do we find more setups like this one? What characteristics do we want to see in our “fade” candidates.
Well, they’re pretty simple actually:
- Prices retesting a former support level (the more significant the better)
- Momentum in a bearish regime (the longer the better)
- A weak stock in a weak sector/industry (relative weakness)
- Well-defined risk and an elevated reward/risk (i.e. 5:1 or higher)
It’s not rocket surgery. By looking for these four characteristics we can identify more opportunities like the one above, before they’re sold into.
I went through the S&P 1500 and picked out over 100 names that are setting up just like Pinnacle Financial Partners did. I went through 4 post-it notes as I did my analysis, which I can assure you is not something that happens in an uptrend.
Thanks for reading and let us know your thoughts!