A beaten-down stock lures in a lot of people who think, “It needs to bounce at some point.” Bottom picking can be a dangerous game, especially without strict risk management rules that stipulate exactly when to throw in the towel. (That goes for all trading, not just bottom picking.) When a beaten-down stock rallies off a low, that can be especially alluring, as it may give the appearance of a reversal. But more often than not, it is better to trust the trend. If the trend is down, it is often wise not to buy into the stock, and traders may be better off selling or shorting the shares instead. In this article, we look at two stocks are still in downtrends despite a recent bounce.
Snap Inc. (SNAP) shares rallied in August, pushing up from the $11.28 low. The rally faltered near $15, moving sideways for several sessions. In early September, the price has fallen off the $15 level. While the stock could continue to edge higher, the $15 region is likely to be a significant resistance level, with an additional resistance region just above it between $16.30 and $17. That does not leave a lot of upside, and downtrends tend to make new lows. If the downtrend continues, the price would likely sink back below $11.28. With the price currently near $15, there is more room on the downside than on the upside.
The outlook would change only if the price continues to rally in a strong fashion. If the price can climb above $18, at that point, the downtrend would be drawn into question, and traders could consider long positions on the pullback, assuming that the pullback stalls and starts rising again well above the $11.28 low. (See also: Snap Sees ‘Fierce’ Pressure From Copycats: Wedbush.)
Marathon Oil Corporation (MRO) is another stock that has rallied off its August bottom at $10.55. During 2017, rallies have typically advanced 7% to 17% before giving way to more selling. In September, the price has been as much as 9% off the low, so it would not be out of the norm to see the shares push a bit higher. Based on the tendencies in the stock, a major sell area is $12.25 to $12.50, as that is about 17% off the low.
The price could falter before that, though, as most of the rallies over the past eight months have faltered after advancing only 7% to 10%. This leaves limited upside potential and more room on the downside, as the price is likely to slip back below $10.55. While the price may stall at or just below a prior low in a downtrend, it often moves below that level. Looking at similar tendencies on the downside, a target for the decline is $10 to $9.50. (For more, see: Marathon Oil Q2 Loss Wider Than Expected, Revenues Beat.)
The Bottom Line
It is important to keep the trend in mind. If the trend is down, it may be alluring to try to bottom pick. While this tactic may occasionally work, most traders are better off selling or shorting on the short-term rallies instead of buying them (during a downtrend). Since downtrends tend to make lower lows, as long as the downtrend is intact, there is usually more room on the downside than on the upside. However, trends do reverse. If a rally in a downtrend is big enough to erase the prior major down wave, that draws the downtrend into question. If the price then makes a higher swing low, an uptrend may be under way, and it is a better time to buy. (For additional reading, check out: Market Reversals and How to Spot Them.)
Charts courtesy of StockCharts.com. Disclosure: The author does not have positions in the stocks mentioned.