It doesn't really matter whether this week's selling pressure is the start of a larger-scale correction or the pause that refreshes ahead of a new rally leg. More important, traders and investors need to respond proactively to whatever the ticker tape throws at us to take our fair share of money out of the market.
I'm talking about a flexible approach in which we accept the recent selloff at face value, raise cash levels and start the hunt for strong stocks that are starting to pull back to substantial support. At the same, let's consider the likelihood of another false breakdown by building a list of momentum plays that have held up well through the downdraft.
This bilateral approach will only work well if we pay close attention to what the market tells us in the next week or two. Here are the initial questions: Do we hold our ground after Monday's breakdown of the two-week trading range? Do the big gaps posted that day get filled and do sellers return in force when that happens?
This week's downswing gives us several levels to watch as the battle lines are drawn. The key to the
index lies at 940 at the upside and 894 on the downside. The top number is self-explanatory because it marked Monday's breakdown level. At the other end, the lower number points to support at the 50-day moving average.
This is a line in the sand because a selloff through that number might not stop until 880, which would completely unravel the last leg of the four-month rally. That would be bad mojo because the index has posted a higher low after each pullback since March. That violation would end the bullish string and yield a first failure pattern that might herald an even stronger decline this summer.
I suspect that price action between now and the end of the quarter will fool the majority of talking heads, both bullish and bearish, because this isn't the right time to stick with a rigid market view. Sitting back and watching as the battle unfolds will also help us to keep our heads on straight until the next batch of low-hanging fruit comes along.
While we wait, let's look at three interesting setups triggered by this week's price action.
Cadence Design Systems
sold off from $25 to $2.42 and bounced in October. It tested that level in December and printed a bullish double bottom reversal. The subsequent uptrend rallied above the 200-day moving average in early May. The rally promptly stalled and gave way to a broad consolidation pattern.
The stock tested the May high last week and sold off with the broad market on Monday. It's now filling out the last stages of an ascending triangle, which is a bullish pattern that should give way to a renewed uptrend in the weeks ahead. The higher lows mark support for this setup, so keep a stop-loss under the blue trendline just in case things go haywire.
All sorts of industrial metal stocks are selling off this week as market players take profits after the sector's strong rally. Triple witching expiration is contributing to the downdraft because leadership groups tend to act poorly during these quarterly events. As a result, it is likely these issues will recover and rally back to their highs before month's end.
is a good-looking sector play that rallied into the 200-day moving average in May, paused there for nearly two weeks and then gapped higher on strong volume. The stock hit $11.52 last week and then turned sharply lower. Keep a close watch on the unfilled gap near $9.50 because a selloff into that level should offer a great entry.
Low-priced stocks have been on fire in recent weeks, as momentum players pour their hot money into these garbage issues. Of course, many of these companies haven't made a dime in years and face considerable economic headwinds, so any trade entry requires sound risk management skills and a tight stop loss.
( BGP) sold off from the mid-$20s bottomed out at 34 cents in December. It rallied out of a tight basing pattern in March and shot up above the 200-day moving average earlier this month. It's now pulling back, after hitting a higher high on increased volume. The stock should bounce at support above $2.70 and continue its strong rally run.
Please note that due to factors including low market capitalization and/or insufficient public float, we consider Borders to be a small-cap stock. You should be aware that such stocks are subject to more risk than stocks of larger companies, including greater volatility, lower liquidity and less publicly available information, and that postings such as this one can have an effect on their stock prices.
Alan Farley provides daily stock picks and commentary with his "Daily Swing Trade" newsletter.
Know What You Own: Other technical and system software companies include VMware (VMW) - Get Report, Autodesk (ADSK) - Get Report, Synopsys (SNPS) - Get Report and Ansys (ANSS) - Get Report. For more on the value of knowing what you own, visit TheStreet.com's Investing A-to-Z section.
At the time of publication, Farley had no positions in the stocks mentioned, although holdings can change at any time.
Alan Farley is a private trader and publisher of
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