Undercut, Go and Retrace
Note: The historical stock examples given below are for EDUCATIONAL USE ONLY. They ARE NOT to be used to make buy/sell decisions in today's market. For more information, please read the HSR Terms of Use.
Description
This price behavior unfolds in three (3) steps:
Step 1: Price breaks/undercuts a support level within a base/consolidation.
Step 2: The following week or several weeks later, price rallies back inside the broken support level.
Step 3: Price meets resistance and corrects to the violated support level from Step 1.
Behavior Notes:
- This price behavior is another potential outcome of Undercut and Go. All of the steps are identical except for Step 3 because price comes back down to test the original support level that failed to hold price in Step 1.
- A stock market that undercuts a prior low may be helpful in determining the potential of an individual stock's base. If the market makes new lows on the undercut, but the stock doesn't (Undercut, Go and Retrace), that's a positive indicator that the stock has potential to move higher.
What you need to know
Given the backdrop of a market uptrend, price may rally after retracing to a former support level that was once violated.
This may happen for two reasons:
1. Short Positions Covered at the Break-Even Point
After a breakdown fails and price rallies back inside the range, the once violated support level may be reborn as new support.
This may occur because anyone who shorted (bet that the stock will go lower) the break of support (Step 1 above) is now on the wrong side of the market.
Some may cover (buy back) their short positions if the market gets back down (retraces) to their original entry point.
If that occurs, short positions can be closed out with minimal losses, but the buying action helps buoy price.
2. Short Positions Covered Late
There may be some who don't cover at the break-even point.
Instead, they hope that price will roll back over.
When it doesn't and starts to move away from the break-even point again, many will cover their positions at a loss.
This 2nd round of buying helps add to the upside momentum that started at the original support level.
In the end, it's helpful to understand the psychological forces that may move stock prices.
Historical Stock Chart Examples 1A & 1B: Children's Place (PLCE) 1998
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Click to enlarge 1A
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Click to enlarge 1B
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