The Stock Markets Are Talking… Plus, How to Trade Pullback Patterns

In last week's article, we said we'd find out a lot more about the recent rally attempt by how we pull back.

Well, we're still waiting.

Sure, we pulled back on Monday ― but not enough to relieve an overbought condition. Don't get us wrong, we'd love to be buyers on the long side. However, we are NOT going to chase stocks.

We need to see patterns that we can actually work off, versus highly emotional money chasing things. That's not what we do and that's not how we've earned over $34,000 in 8 months.

Now that we've had a strong rally, the most important pattern that we want to key in on from here is the Pullbacks Off Highs (POH) longside entry pattern.

We also said: Don't Rule out a retest of the highs in the short term either though as the market's new short-term resistance may yet need to be tested one more time if we are going to work lower in the short-term. In so doing it would create a Double Top (the early warning sign that a change in trend from up to down is near) assuming it sticks and rolls back over from there.

Thursday we got the retest in the form of the "Mark to Market" news. Then on Friday we got the employment numbers.

As of this moment, this is what we are seeing. We hate to sound like a broken record, but it is what it is…

What's so special about Thursday's highs?

The Dow bumped its head on the 61.8% Fibonacci level which as far as retracement levels go this is a pretty standard level where one can expect a pullback. Other levels are shown as well at the 38.2% and 50% retacements. This is another way the market talks to us.

How to Trade Pullback Off High Patterns

Now that the market has rallied impressively, normal, positive action would be for it to pullback to consolidate its gains before resuming a new move higher. The same is true for individual stocks.

These pullbacks, or mini-downtrends, are our opportunities to get positioned to benefit from a stock's next leg up. Let's take a look at a classic example:

Each pink line represents a pullback off highs pattern. Notice how each pullback is usually a normal pullback to an area of strong support such as an upward trendline or the 50-day moving average? And the pullback resets the full stohcastics to oversold territory. This combination is very healthy action and it is what we are seeing in some stocks that just might be the leaders of the new rally.

In fact, we have three stocks on our current watch list that are in a new uptrend and are currently forming their second pullback off highs pattern (second pink line) after making strong gains when they emerged from their first pattern.

So what do we do with these patterns? It's really simple, a break above the pink line triggers a trade on the long side.