Abuba Networks ARUN: Beaten-Down Small Cap Looks Poised for a Powerful Breakout

Buying on weakness and selling on strength is the hallmark of the professional trader. While the average Joe investor attempts to buy stocks as they are climbing higher, the professional quietly waits for prices to drop in order to enter positions.

Obviously, not all declines should be bought. Sometimes a falling stock just keeps on falling until it's close to zero. Professional traders call the attempt to buy stocks that keep dropping trying to catch a falling knife.

The question is how does one tell the difference between a falling knife and a simple pullback that should be bought? Here are three ways to help you tell:

1. Determine what caused the pullback.
If the pullback was caused by a one-time special situation, like an earnings warning, negative rumors, or even the selling of shares by an institution, this can create an opportunity to purchase shares at a discount. However, if the negative news comes in waves or something fundamental changes at the company, this could mean that prices will continue lower.

2. Watch the 200-day simple moving average.
The basic rule of thumb with the 200-day simple moving average is that shares that are in the process of dropping and are below that moving average should not be purchased. This can act as a line in the sand between buying and selling pressure. If shares are below the 200-day moving average and start to climb higher, this can be a buy signal depending on what caused the pullback. (more)

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