Hedge Fund Manager Reveals his Perfect Pullback Trading Setup

Name: Hedge Fund Manager Reveals his Perfect Pullback Trading Setup
Uploaded: 2021-09-16T21:59:33.000Z
Duration: 3 h 34 min 14 s

Buying Pullbacks: Insights from Charles Harris

Introduction to the Speaker and Topic

Charles Harris, a portfolio manager at O'Neill Capital Management, discusses his approach to buying pullbacks in stock trading.

He expresses gratitude for being invited and praises the quality of previous speakers at the conference.

Emphasizes that there are multiple successful strategies in trading, highlighting his unique focus on buying pullbacks.

Personal Trading Philosophy

Stresses the importance of aligning trading strategies with personal strengths and personality traits.

Notes that many investors aspire to replicate Bill O'Neil's success but acknowledges that not everyone possesses his unique skills or risk tolerance.

Shares his background with O'Neill Global Advisors since 1995 and how he learned directly from Bill O'Neil.

Approach to Buying Pullbacks

Describes his method of swing trading around core positions, aiming for significant long-term gains by identifying high-potential stocks.

Discusses how he buys during market pullbacks when others are selling, which is contrary to typical market behavior.

Market Conditions for Buying Pullbacks

Highlights the necessity of being in a defined uptrend or bull market when considering buying on weakness.

Explains that he typically already holds a position before purchasing more shares during pullbacks.

General Rules for Buying Pullbacks

States that while nothing revolutionary will be discussed, it’s crucial to consider buying opportunities during stock pullbacks rather than just focusing on breakouts.

Points out that all major winners tend to retrace towards their moving averages; thus, traders should capitalize on these moments instead of avoiding them.

Understanding Stock Trends and Trading Strategies

The Importance of Uptrends in Stock Trading

A stock must be in a strong uptrend, characterized by higher highs and higher lows, supported by a rising 50-day moving average to take advantage of pullbacks.

Conviction in a stock is essential; it should be fundamentally strong with compelling prospects to buy during market weakness.

Buying against the grain requires mental grit; understanding what you own is crucial for making informed decisions.

Liquidity and Institutional Sponsorship

Stocks should have good liquidity relative to your account size for easy buying and selling, especially when needing to reverse positions.

Focus on institutional-type stocks that attract big money, as they provide better support at critical levels.

Lack of sponsorship often indicates low liquidity, which can hinder trading effectiveness.

Risk Management and Trade Objectives

When entering trades, aim to increase winning odds while clearly defining potential losses for effective risk management.

Typical strategies involve buying strength when stocks break above resistance levels with increased volume.

Examples of Effective Trading Strategies

An example includes buying Kupa Software after it broke out from a cup-with-handle base on high volume, increasing the odds of success due to cleared overhead supply.

Position pyramiding can occur as stocks continue to rise after breaking resistance; however, it's important to monitor for corrections.

Challenges with Traditional Buying Methods

While traditional methods work well in bull markets, they often lead to higher cost bases since you're buying at new highs.

Competing with others at obvious buy points can make successful accumulation difficult; breakout failures are increasingly common.

Alternative Approaches: Buying Pullbacks

An alternative strategy involves initiating or adding positions during pullbacks rather than only at breakout points. This method aims to mitigate some disadvantages associated with traditional buying strategies.

Buying on Pullbacks: Strategies and Insights

Advantages of Buying on Pullbacks

Initiating positions during pullbacks allows for a lower cost basis compared to buying at new highs, making it easier to accumulate shares when supply-demand dynamics favor the buyer.

This strategy takes advantage of fearful sellers who are shaken out at support levels, providing an opportunity to buy stocks at discounted prices.

Timing Your Purchases

Investors can buy on pullbacks either before a breakout while a stock builds its base or after breaking out when certain support areas are established.

It is advisable to wait for an upside reversal as an indicator before purchasing during a multi-day pullback, signaling potential upward movement.

Understanding Upside Reversals

An upside reversal indicates supporting action and the shakeout of weak holders; ideally, this should occur on heavy volume and near support areas.

If the stock breaks below the pivot point after an upside reversal, it signals that the trade may not be valid anymore, necessitating loss management.

Practical Example: Skyworks Solutions

The example illustrates how Skyworks Solutions built its right side post-COVID crash, moving above key moving averages but still requiring caution regarding entry points.

A three-day pullback ending in an upside reversal with increased volume provides a chance to initiate positions early without waiting for a breakout.

Managing Risk and Positioning

Setting the intraday low of the upside reversal as a stop-loss helps manage risk effectively; personal tolerance levels dictate whether one acts immediately or waits until day-end.

Additional purchases can be made if another upside reversal occurs in conjunction with traditional pivot points, allowing for multiple entries before breakout confirmation.

Consolidation and Further Opportunities

After initial buys, further opportunities arise during consolidation phases where stocks may pull back to moving averages like the 21-day average.

Pyramiding into strength as stocks clear resistance lines enhances position size while managing risk through defined entry points.

Case Study: Lululemon's Recovery

Lululemon experienced significant corrections but showed strong recovery signs with heavy volume bounces followed by five-day pullbacks culminating in upside reversals.

Early positioning can be beneficial even if initial conditions aren't perfect; defining losses clearly allows investors to build their positions confidently.

Understanding Stock Trading Strategies

Analyzing Stock Movements and Buying Opportunities

The stock initially moves up for a few days, retesting the pivot area before showing another upside reversal. This tight action indicates a potential buying opportunity.

After the second breakout, there is an additional upside reversal, suggesting it’s a good point to add to your position by buying strength.

Traders may get shaken out after two losing trades in quick succession, leading to hesitation in purchasing during subsequent opportunities.

A sustained uptrend follows the last breakout, with normal pullbacks that provide chances to buy on weakness as the stock consolidates.

The 21-day moving average plays a crucial role in containing price action and offers points for adding positions during shakeouts.

Identifying Risk and Support Levels

Multiple areas of buying on weakness are highlighted, emphasizing the importance of recognizing upside reversals during pullbacks.

Heavy volume signals can indicate ominous sell-offs; traders should consider scaling out of their positions when faced with significant losses.

Before breaking out of a base, waiting for an upside reversal is essential for defining risk since stocks often trade below moving averages at this stage.

Upside reversals serve as supporting actions that help define risk levels before entering positions; without them, determining where to cut losses becomes challenging.

Once in an established uptrend post-breakout, additional support areas emerge that allow for better risk management without needing to wait for further reversals.

Utilizing Moving Averages Effectively

Key moving averages include the 10-day moving average (MA), 21-day exponential MA, and 50-day MA; these are critical indicators during defined uptrends.

The 10-day MA helps keep traders invested rather than serving as an accumulation point due to its proximity to price action; substantial pullbacks are preferred for new entries.

Tesla serves as an example where significant gains were achieved while adhering closely to the 10-day MA throughout its powerful advance from December 2019 onwards.

During Tesla's rise, multiple upside reversals occurred along the 10-day MA which provided opportunities for traders to pyramid their positions effectively.

Understanding Stock Pullbacks and Moving Averages

The Role of the 21-Day Moving Average

The 21-day moving average often indicates a stock's pullback, allowing for potential buying opportunities when prices drop by 10-15% before reaching this line.

In the example of Koopa, the stock advanced significantly while being supported by the 21-day moving average, showcasing its importance in identifying entry points during pullbacks.

Utilizing Upside Reversals

Traders can capitalize on upside reversals at the 21-day moving average to add to their positions, which can lead to better cost bases compared to buying at new highs.

The 50-day moving average serves as a classic support level for many successful stocks, often revisited multiple times during an uptrend.

Swing Trading Strategies

Taking profits into strength allows traders to feel more comfortable when stocks pull back, enabling them to buy shares again at lower prices.

Aggressively buying the first pullback to the 50-day moving average is a common strategy among traders looking for recovery opportunities.

Case Studies: C Limited and Zoom Video

C Limited demonstrated significant price movement contained within its 10-day moving average post-breakout, illustrating how strong trends can persist despite appearing extended.

Zoom Video provided multiple chances for investors to buy on pullbacks near its 50-day moving average, each resulting in subsequent upside reversals.

Managing Risk During Pullbacks

A swing trading approach helps cushion against stress during market fluctuations; buying on weakness rather than solely on strength can mitigate emotional reactions.

If a stock decisively breaks below its 50-day moving average after several tests, it signals caution. However, having a cushion from previous gains may allow some flexibility in decision-making regarding position management.

Effective Stock Shakeouts and Trading Strategies

Understanding Shakeouts

A stock's performance at the end of the week can indicate whether it is experiencing a shakeout or if it has genuinely broken down. If a stock decisively breaks below its 50-day moving average, it may signal further decline.

If a stock appears to be in a shakeout phase, it should rebound quickly—ideally the next day. A failure to do so suggests it's time to exit the position and wait for another opportunity.

Identifying Buying Opportunities

A significant buying opportunity arises when a stock is approximately 40% off its weekly low after an effective shakeout, indicating that weak holders have been shaken out.

The example of Acme Packet illustrates this concept; despite challenging price movements, it demonstrated resilience by returning above key moving averages after pullbacks.

Managing Positions Around Moving Averages

Stocks often flirt with their 50-day moving average during volatile periods. Observing behavior around this level can help traders determine whether to hold or exit positions.

Waiting until the end of the week before making decisions can provide clarity on whether a stock is showing strong support or continuing weakness.

Challenges in Trading Psychology

Exiting positions on weakness can lead to loss of confidence, making it difficult for traders to re-enter successfully when stocks show strength again.

The case of Zoom demonstrates how stocks can recover sharply after appearing weak, emphasizing the importance of timing and psychological readiness in trading decisions.

Utilizing Support Levels from Consolidations

In addition to moving averages, previous consolidation peaks can serve as support levels. Traders should look for these areas when considering entry points during pullbacks.

Shopify's breakout from sideways consolidation serves as an example where resistance turned into support effectively over time, allowing traders to capitalize on subsequent price movements.

Risk Management Strategies

When buying near support levels, it's crucial to define risk clearly. If prices close significantly below established support lines or break down through moving averages, traders must recognize they are wrong about their position.

While waiting for upside reversals before entering trades isn't mandatory, doing so often leads to better outcomes by confirming supporting action rather than risking entry on weak signals.

Understanding Upside Reversals in Trading

The Concept of Upside Reversal

An upside reversal indicates supporting action, allowing traders to define their risk clearly. However, it may not be suitable for everyone; comfort and discipline are essential.

Risks of Waiting for an Upside Reversal

Waiting for a reversal day can lead to missed buying opportunities as stocks may pull back without showing an upside reversal.

Case Study: Koopa's Movement

In 2019, Koopa broke out from a base but faced a sharp correction back to prior resistance and the 50-day moving average. Without supporting action, this presented a riskier buy opportunity.

Quick Recovery Example

The next day after the drop, Koopa quickly rebounded, illustrating that waiting for an easy upside reversal might result in missing quick recovery opportunities.

Case Study: Tesla's Performance

Tesla experienced significant volatility with a 34% drop over five days. Despite no supporting action on the gap down day, it reached key support levels where some traders took advantage of the weakness.

Buying Strategy During Weakness

Traders can buy during moments of weakness at support levels. While scaling out is advisable during upward movements, one must be cautious about timing and market conditions.

Advantages vs Disadvantages of Timing Purchases

Buying on strength after waiting can provide confidence but risks being shaken out if another pullback occurs shortly after purchase.

Balancing Risk and Reward in Trades

Attempting to secure the lowest cost basis increases risk; conversely, buying on strength offers reassurance but also potential losses if the stock pulls back again.

Strategies for Buying Near Support Levels

Three methods exist for purchasing near support:

Buy as approaching support.

Wait until hitting support.

Wait until signs of movement upwards post-support hit.

Accumulating Shares During Panic Selling

Buying while stocks are falling allows easier accumulation due to panic selling among other traders. This strategy can yield better prices if executed correctly.

Understanding Stock Pullbacks and Buying Strategies

The Risks of Buying on the Way Down

When purchasing stocks that are declining, there's a risk of "catching a falling knife," which can lead to significant losses if the stock continues to drop.

Investors should identify support levels, such as moving averages or consolidation tops, where they expect the stock to stabilize before buying.

Defining Losses and Entry Points

The goal is to average down when buying during a pullback, ideally getting within 5-6% of the ultimate low without attempting to perfectly time the bottom.

Patience is crucial; investors should wait for stocks to approach defined support levels rather than buying impulsively during declines.

Strategic Buying Techniques

Start with small purchases when entering a position on weakness; this minimizes risk in case of further declines.

True pullbacks often take time (4-8 trading days), so it's essential not to rush into buying decisions.

Importance of Support Levels

Knowing multiple areas of support on charts helps define acceptable loss percentages before making purchases.

If unsure about where support lies, it’s advisable not to buy during weakness until clarity is achieved.

Scaling Into Positions

Look for substantial pullbacks (at least 10% off highs); smaller fluctuations (4-8%) may not warrant entry.

Use a reverse pyramid strategy when scaling into positions on weakness—start small and increase size as prices approach support levels.

Managing Position Sizes

Always determine maximum position sizes beforehand; avoid making impulsive decisions while prices decline.

Case Study: Trading Example with PIN Duo

A successful breakout followed by a pullback can provide good entry points near key moving averages like the 50-day line.

First pullbacks typically offer favorable odds for investment; however, there are no guarantees in trading outcomes.

This structured summary provides insights into effective strategies for navigating stock market pullbacks while emphasizing patience and careful planning.

Buying Pullbacks: Strategies and Insights

Understanding Entry Points in Stock Trading

The speaker discusses the importance of waiting for a favorable entry point when purchasing stocks, emphasizing the need to identify support levels before making a move.

A successful strategy involves looking for an upside reversal at key support levels, particularly around the 50-day moving average, which can signal a good buying opportunity.

If trading around a core position, traders should consider recouping shares after a sufficient pullback (20% off highs), allowing them to capitalize on potential rebounds.

Managing Risks and Expectations

While there are risks associated with buying near support levels—such as potential shakeouts or failures—the speaker notes that these risks can lead to significant gains if managed properly.

The presentation emphasizes patience and conviction in identifying support levels; understanding where these lie is crucial for effective trading strategies.

Discipline Over Conviction

The speaker stresses that discipline is more important than conviction. Traders must be prepared to cut losses if stock prices break below expected support levels.

It’s essential to define risk clearly whether buying on strength or weakness; this includes knowing when to exit trades based on predetermined loss thresholds.

Q&A Insights on Pullback Velocity

During the Q&A session, the speaker addresses questions about how velocity affects pullbacks and whether short consolidations matter in decision-making.

The discussion highlights that while orderly pullbacks are preferred, volatile drops can also present opportunities but come with higher uncertainty.

Analyzing Pullback Patterns

The speaker suggests analyzing past big winners' charts to understand different types of pullbacks—both orderly and volatile—and their outcomes within larger uptrends.

Ultimately, both types of pullbacks can work in an uptrend; however, they may evoke different emotional responses from traders due to perceived risk.

Trading Strategies and Risk Management

Embracing Risk in Trading

The speaker discusses a contrarian approach to trading, indicating a willingness to take advantage of market panic, which may involve higher risk strategies.

They reflect on past experiences where impulsive decisions led to significant losses, emphasizing the importance of patience in trading.

Importance of Patience and Defining Risk

The speaker stresses the necessity of waiting for stocks to reach defined support levels before making trades, highlighting that not all opportunities need immediate action.

They caution against settling for less than ideal entry points, advocating for strict adherence to personal trading criteria.

Stop Placement and Trade Considerations

A question about stop placement during upside reversals is addressed; stops should be set below the intraday low of the day.

The speaker notes that some traders sell immediately upon breach of this low while others wait for confirmation through stock behavior.

Evaluating Overall Positioning

When considering new buys around core positions, it's crucial to remember any locked-in gains as they provide a cushion against potential losses.

The speaker emphasizes evaluating each trade within the context of total portfolio exposure rather than in isolation.

Managing Position Size and Cost Basis

Discussion on how much capital to allocate at different buying points; concentrated positions require careful management to avoid becoming top-heavy.

Buying on pullbacks can help maintain a favorable cost basis but requires caution not to dilute initial investment advantages.

Timing Entries Around Key Levels

On deciding when to buy after a shakeout below moving averages, the speaker prefers early entries based on intraday volume signals rather than waiting until day's end for confirmation.

They acknowledge that while early entries carry more risk, they can also lead to better positioning if executed correctly.

Understanding Pullback Strategies in Stock Trading

Entering Positions After Upside Reversals

The speaker discusses the strategy of adding to positions after an upside reversal, emphasizing a cautious approach to avoid chasing stocks unnecessarily.

They express comfort with their initial entry point and prefer not to overextend by continuously adding shares unless the stock proves itself further.

Market Conditions and Buying Pullbacks

A question arises about when to stop buying pullbacks, particularly in relation to negative market actions or overall market conditions.

The speaker highlights that a strong uptrend and forgiving market conditions are essential for successfully employing a pullback strategy.

Indicators of Market Weakness

They note that an increasing loss rate is a key indicator of changing market conditions, suggesting traders should be vigilant about their win-loss percentages.

The discussion includes the importance of rotating into different sectors as markets shift, especially during periods where growth stocks may underperform.

Challenges in Current Market Dynamics

The speaker reflects on the current bull market's complexity, noting that while it appears strong overall, specific sectors like O'Neill-type stocks have faced challenges.

They advise against using pullback strategies if support levels are consistently failing, as this indicates broader weakness in the market.

Specific Strategies Regarding Moving Averages

A question is posed about trading off the 200-day moving average; however, the speaker typically avoids this due to its indication of a stock being in a base-building phase rather than an uptrend.

They mention maintaining a core position in Tesla but emphasize treating it differently from other stocks due to its unique potential and past performance.

Fundamental Analysis Over Technical Signals

When discussing Tesla specifically, they indicate that fundamental analysis plays a more significant role than technical chart patterns for them.

The speaker compares Tesla's potential with Apple and Amazon based on historical performance data and expresses caution against over-trading which can negatively impact positions.

Insights on Leadership and Market Trends in Tech Companies

Similarities Between Amazon and Apple

The speaker highlights the iconic leadership of both Amazon and Apple, noting their innovative approaches and significant market presence.

Both companies are recognized for their strong product innovation, which has contributed to their dominance in large end markets.

Reflections on Apple's Historical Performance

The speaker expresses a desire to avoid mistakes similar to those made with Apple, aiming for substantial growth without overcomplicating strategies.

Since 2004, Apple has experienced ten corrections ranging from 25% to 50%, yet it has only had three down years during this period.

The average correction depth for Apple is noted as approximately 37%, indicating the volatility that investors must navigate.

Current Market Positioning of Tesla

Tesla's stock has seen a significant decline of nearly 40%, but the speaker remains optimistic about its long-term potential despite current negativity surrounding it.

The speaker plans to maintain their position in Tesla while waiting for signs of recovery before adding more shares.

Comparisons with Amazon's Stock Behavior

Amazon is mentioned as having more down years than Apple; however, once stocks like Amazon are up significantly, they rarely experience severe downturns unless faced with a major bear market.

The average drawdown for both Tesla and Amazon stocks is around mid-30%, reflecting typical volatility patterns in high-growth tech stocks.

Future Outlook on Investment Strategies

Despite current challenges, the speaker believes that Tesla could be positioned well for future growth opportunities across various sectors such as alternative energy and AI.

Reflecting on past performance, the speaker notes how fortunate they were last year when certain stocks saw substantial gains (up seven or eight-fold).

Analyzing Recent Stock Movements

A discussion arises regarding pullback thresholds; specifically, a minimum pullback of 10% is preferred by the speaker when assessing stock strength.

Concerns are raised about UPST’s sharp pullback due to an upcoming lock-up expiration; historical trends suggest buying weakness may have worked previously but carries risks.

Lock-Up Expiration Effects on Stocks

The impact of lock-up expirations on stock prices is discussed; previous experiences indicate potential volatility around these events.

Observations about UPST’s trading volume characteristics highlight unusual patterns leading into its lock-up period, suggesting investor interest despite recent declines.

Growth Stocks and Market Trends

Insights on Growth Stocks

The speaker discusses a growth stock that is currently profitable, emphasizing confidence in its potential due to its alignment with the artificial intelligence sector, which is expected to be significant over the next decade.

There are indications that growth stocks may be recovering after a bear market, although there remains uncertainty about their stability. The speaker expresses willingness to invest despite potential risks.

A specific stock has recently dropped 34% in a short period; the speaker plans to buy at this level but acknowledges the lack of supporting action for now.

Trading Strategies and Position Management

The speaker outlines their stop-loss strategy, expecting a reversal if the stock opens lower but closes above certain levels. They reference previous setups with similar patterns in other stocks like Koopa and Tesla.

They describe incremental buying strategies near moving averages, indicating past experiences where initial purchases did not yield expected support.

Technical Analysis and Stock Behavior

The discussion includes technical analysis tools such as zooming in on charts for better visibility of price movements and support levels during trading sessions.

The speaker reflects on their trading history with this particular stock, noting they have bought and sold it profitably during pullbacks while also missing out on larger gains due to volatility.

Risk Management During Earnings Reports

They express caution regarding holding positions through earnings reports due to unpredictable price movements post-announcement.

Emphasizing the importance of timing, they mention how rapid price changes can make it challenging to trade effectively without early entry points.

Reversal Patterns and Trading Decisions

The conversation shifts towards recognizing upside reversals as key indicators for making trades. Successful trades were made by waiting for these signals rather than taking riskier positions at support levels.

Finally, they discuss their approach toward earnings announcements, highlighting the difficulty of trading around these events given the inherent volatility associated with them.

High Conviction Stocks and Market Dynamics

Discussion on a High Conviction Stock

The speaker expresses a strong belief in a particular stock, noting its solid fundamentals and potential for growth despite lacking mutual fund sponsorship.

Notable investors like Soros hold significant positions in the stock, indicating confidence from experienced market players.

The speaker reflects on the challenges of trading this stock effectively due to market volatility, highlighting instances where they were shaken out of positions.

Transitioning to Reopening Trades

The speaker mentions their second-largest position in Starbulk (SBLK), emphasizing a successful transition from growth stocks to reopening trades.

They detail their trading strategy with SBLK, including buying at key levels and locking in gains while maintaining a core position for future growth.

Shipping Industry Insights

The shipping industry is discussed as being favorable now after years of poor performance; the dynamics have shifted towards profitability.

Historical context is provided regarding overbuilding during 2007-2008, leading to current supply-demand advantages for shipping companies.

Performance Metrics and Future Outlook

The Baltic Dry Index has seen significant increases, suggesting that shipping companies are becoming profitable again and starting to pay dividends.

The speaker believes turnaround plays in this sector can yield substantial gains, expressing confidence that SBLK could double in value.

Selling Strategies and Market Timing

A discussion arises about strategies for scaling out of stocks; selling into strength is noted as more challenging than buying weakness due to uncertainty about price movements.

Effective methods for selling include waiting for downside reversals or extensions beyond moving averages; however, powerful stocks may defy these patterns.

Investment Strategies and Tax Considerations

Hybrid Investment Approach

The speaker discusses a bifurcated investment strategy, allocating half of their account to Tesla while actively trading the other half among various stocks like Upstart (UPST), Path (PATH), and Star Bulk. They aim to compare which approach yields better returns after taxes over one or two years.

Emphasizing a hybrid approach, the speaker balances holding core investments with active trading. They express uncertainty about whether this strategy maximizes results due to the tax implications of short-term gains.

Tax Implications in California

The speaker highlights the significant tax burden in California, noting that paying over 50% in taxes makes it challenging to achieve substantial investment returns. They mention trading primarily within an IRA to avoid capital gains taxes.

Their largest trading account is a Roth IRA, allowing for more flexibility without tax burdens. They express caution regarding their large position in Tesla, wanting to avoid mistakes that could jeopardize potential future gains.

Trading Experiences with Tesla

The speaker shares past experiences where selling Tesla led to missed opportunities as the stock continued to rise significantly after each sale. This has created anxiety around maintaining their position in high-conviction stocks.

They plan to trade Tesla based on apparent surges but anticipate slower growth moving forward compared to previous years. The expectation is for more gradual increases akin to Apple or Amazon rather than explosive growth.

Future Trading Strategy

The speaker acknowledges that they have initiated a position in Tesla but did not buy during its breakout phase. They are cautious about how they will manage this investment going forward, considering market conditions and potential price movements.

Conference Wrap-Up

As the discussion concludes, there’s recognition of information overload from the conference sessions. The speaker expresses gratitude for participation and looks forward to future discussions while encouraging attendees to revisit content as needed.