There are two valid buy points in an undercut and rally setup (#URS) because there are two proper undercut and rally patterns.
- Price undercuts a prominent prior low a couple days/weeks or even month ago and closes at the bottom of the daily range on high volume, giving the impression of weakness. In this case price normally gaps up through the prior low-line the next day (because selling is exhausted) which then triggers the entry right away at the open similar to how a Momentum Gap Setup (#MGS) is handled.
- Price undercuts a prominent prior low, reverses on the same day and closes green on normal volume. In this case you just buy when price rallies up through the low-line. Could be on the same day or the very next. Reading the volume correctly can be tricky here. When volume is not coming in on the undercut it is generally a sign that selling pressure is low [bullish]. This can result in a low volume rally up through the low-line. However sometimes buyers simply step in with authority thus absorbing any selling for good. In such a case the volume will be high [also bullish].
A shakeout can cover a large range so it is oftentimes not feasable to place the stop below the lows of the undercut day. It is better to place the stop below the low line and idealy below any PLL created inside the bar on the day of the undercut.
The undercut and rally setup is my least preferred long setup because it is so easy to spot on a chart that almost all weak bottom-fishers use it. Screening for it is not straight forward (I don’t screen for it) but it’s also not needed. When the market flashes some forced selling following a correction, you simple go through the charts of the former leaders trying to spot any proper #URS. Buying the setup in the post IPO phase can allow one to catch a sharp entry but from a risk/reward standpoint, it is probably not worth it. However the #URS can be the first bullish clue and sign of strength in such names thus is an enabler for proper follow up setups.
Some more examples will follow soon.