During weak market conditions, the number of potential plays drastically decrease. Due to low volume in buying, prices tend to consolidate in a sideways direction and settle at key support levels in the short to medium term. During this period, prices will often move in tight ranges and hover to and from multi-year support levels. At times, some big institutional players may exit major stock positions and cause short term support breakdown.
When you notice the market is undergoing a consolidation or base formation phase, the type of plays available become very limited. One of the few reliable strategies applicable for such market conditions is a Bounce Play strategy.
What is a Bounce Play?
A Bounce Play is a price action pattern wherein a falling price pivots at a key support level. The precursor for the pivot or reversal is a spike in demand that is translated to heavy buying activity at the support level.
When this happens, a selloff reverses in the short term and forms a pivot structure. Being able to trade the bounce in price can translate to quick profits if executed correctly.
The chart above illustrates a typical bounce play setup within a base formation pattern. What the price action is telling you in this context is that the support area near 80 php exhibits strong buying activity which pushes the price upwards each time it dips near it. Notice as well that the bounce occurs whenever the RSI goes near or below 30.
This type of bounce formation is very apparent on fundamentally strong stocks during weak market conditions. Early recognition of such patterns will allow traders to position near support levels and sell quickly at a profit at each bounce.
Note that Bounce Plays can be executed at different time frames (from intraday to monthly ranges). In the context of this post, we will stick to daily time frames and illustrate standard Bounce Play patterns for the purpose of familiarization.
Technical Signals Leading to the Bounce
Like all chart patterns and plays, there are technical signals that point towards a high probability of a pattern emerging. Here are a few notable signals to look out for when you want to trade a Bounce Play.
1. Fundamentally Strong Stocks with RSI hitting Oversold Levels
Due to weak market demand, some fundamentally robust stocks may also retrace back to support due to lack of institutional buying. This may open up opportunities to score quick Bounce Plays.
The chart above shows a bluechip stock that encountered heavy selloff after the overall index crashed due to the pandemic crisis. Observe how the price sharply bounces when the RSI goes below 20. A fundamentally robust stock going below the RSI 20 level is a strong buy signal. Oftentimes, major institutions will quickly buy up the price causing the price to shoot back up. The bounce in the chart above made a 50% rally in 1 week.
2. Price Near a Key Support Level
A Key Support Level is a price range in the stock chart where there is a strong concentration of buying. This can be seen in the chart as a price level wherein the price fails to go down any lower. This forms an area of support where the price can bounce to, should it dip again near that price level.
The chart above shows a typical bounce formation at a key support level. The initial bounce last December 2019 at 1.00 php validates the support level. The price retraces back to this level on March 2020 and is again met with a strong demand in buying. Thus a second bounce formation formed creating what is called as a Double Bottom Reversal.
Notice that the RSI is near 20 as well when the bounce took place.
3. Bullish Reversal Patterns
Reversal patterns are chart pattern formations that point to a major shift in trend. Bullish Reversal Patterns show a trend shift from a downtrend to an uptrend. During a Bullish Reversal, several bounce in price may occur which translates to numerous opportunities to profit in the short term. There are two common reversal patterns that illustrate this:
a. Double Bottom
A Double Bottom pattern is a typical reversal pattern that occurs in a stock’s key area of support. After a stock bounces from a major downtrend, the price will likely retest the support area to validate the strength of the buying pressure. As more buyers come in, another bounce is triggered and eventually propels the stock price to break its initial resistance.
b. Bullish Divergence
A Bullish Divergence is illustrated in the chart when a contradiction forms between the price and the RSI. This signal happens when the indicator (usually the RSI) is making HIGHER lows while the price action of the stock is establishing LOWER lows. This signifies weakening selling pressure that might transition to an uptrend rally.
Bounce Play Parameters
Now that you know the technical signals to watch out for, let us reinforce the strategy by emphasizing the common parameters that should be present for a successful bounce to take place:
Overall Index is in the process of forming a basing pattern/consolidation pattern
RSI is near or below 20
Above average volume turnover when RSI dips to oversold levels
Price is near multi year support levels with signs of institutional accumulation
Selected stock must display strong fundamental value to attract bargain hunting at key support levels.
Remember that Bounce Plays occur often during weak market conditions wherein prices dip down to oversold RSI levels. When the overall market rallies and transitions to a momentum setup, bounce plays become scarce. This is why you should be very aware of the overall market condition so that you know which strategy is applicable. This is an integral step towards your success in trading.
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