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What is the optimal pullback before buying stocks?

/The article is intended for novice traders. More training materials can be found here: https://www.varchev.com/trading-uni.htm. /

As with many investing questions, the answer is “It depends.”

The two biggest things to keep in mind are:

  • We don’t want to keep buying the same stock at the same price;
  • We want every purchase to matter — meaning it should provide a more attractive return than our last purchases.

Each stock has its own characteristics.

A stock’s volatility, valuation, investor perception, along with short-term factors (earnings, industry data, upcoming shareholder event) all play a role in calculating the potential pullback.

Let’s consider a stock that trades in a narrower range or has a lower valuation, such as Morgan Stanley. A narrower scale of price change means a smaller decline in percentage terms. This means that a smaller pullback in percentages can be expected before entering a position. Big moves are not as frequent at Morgan Stanley as they are at Nvidia, for example.

Stocks like Nvidia, which tend to be more volatile would make a bigger pullback in percentage terms, meaning you’d probably have to wait for a bigger % decline before positioning.

The volatility of a company’s stock can be easily observed. One measure that can help is a stock’s “beta,” which measures its historical volatility relative to the overall market (usually measured against the S&P 500). A beta of 1 would mean that the stock’s volatility is equal to the broader market. A beta above 1 indicates more volatility than the market. And a beta below 1 would indicate less volatility.

Nvidia has a 52-week beta of 1.88, indicating that it has been about 88% more volatile than the broader market average. So a 1% move (up or down) in the S&P 500 would theoretically lead to a 1.88% move in Nvidia. On the other hand, Morgan Stanley’s 52-week beta is 1, indicating roughly the same type of volatility as the market.

Tracking potential bounce levels in the major indices can also be a good indicator of whether the market is ready for new cash inflows.

Another factor is all the upcoming catalysts that may suggest whether to be a bit more aggressive with purchases or more passive. The lack of a near-term catalyst may cause us to remain a little more patient, as the lack of catalysts may limit short-term growth and may lead to further decline.

In conclusion, it is good to combine all these factors to assess whether the pullback is deep enough to develop a new appreciation. Technical analysis is also a good method of determining the end of a pullback using breakouts of established downtrends or breakouts of key resistance levels.

/The article is intended for novice traders. More training materials can be found here: https://www.varchev.com/trading-uni.htm. /


 Head of Trading Dimitar Kalapov

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