3 Immutable Rules for Buying Rebounding Small Caps

Only a couple of weeks removed from the double-dip sirens sounding around every corner of the financial world, investors have cast aside gloomy predictions in favor of blind bullishness. Traders eagerly chased the market up to dizzying heights to start the week, capping off a massive rally that began early Friday…

Surging stocks are attracting sold-out bulls to some of the most beaten-down names one the market. But it can be dangerous to swing trade an oversold stock— especially if you end up chasing the price during a melt-up move. If you’re looking to pad your portfolio by trading stocks on the rebound, just follow these three simple rules:

#-ad_banner-#1. Don’t try to catch a falling knife This is one of the simplest rules of trading any stock, not just bottom-bouncers. Inevitably, an inexperienced trader will find a beaten-down chart and proclaim that the stock couldn’t possibly go any lower.

News flash: it can go lower, and it probably will until the chart tells you otherwise.

You could even justify your speculation with an absurdly low RSI or even fundamental metrics. None of it matters. When investors want to sell, they will sell.

$8.86 and maybe lower — you don’t want to try your luck with this stock…

2. Learn how to spot a Key Reversal — Once you become familiar with bar charts, you should learn crucial reversal day patterns. A reversal day is defined as a day where a stock posts a new low followed by a higher close.

By itself, a reversal day is inconclusive. You would need additional evidence before entering a trade on the long side after identifying a reversal day. A key reversal day, however, is a clearer signal that a change in trend is near.

A key reversal day is identified when a stock makes a new low on the day, then moves to close higher than the previous day’s high.

3. Identify resistance areas — So you’ve found a stock that has shown evidence that it’s ready to bounce off a bottom and move higher. Now, you need to identify where the stock’s new-found trend will most likely slow — or even turn back. Resistance can occur at round numbers, trend lines, or near areas of congestion on charts:

Notice the gap down in early August. This marks an important area of resistance. If you were long this particular stock, it would be wise to watch how the stock reacts to the blue line. If it fails to attempt to fill the gap, it would be wise for the short-term trader to sell and move on to other opportunities…

Simply put, if a stock bumps into resistance and fails to move higher, it could be a good time to take profits off the table.