Doc Maher uses Technical Analysis to optimize trade entry.
Have you ever been yanked out of trade, only to find that your initial idea was correct? Your timing may be the culprit and contributing to a less-than-satisfactory entry. Improving your entry may help to improve your odds of success, while also reducing the number of times you get stopped out. In the following post I will use a short sale to help illustrate the point that timing is everything.
Selling short is a variation of the familiar mantra "buy low and sell high." If you are not comfortable with going short and switching the order to "sell high and buy low," visit Nicole Wachs' All-Star post, Locogmac Covers Shorts.
THE PLAY - Sell Short Stock
TRADE FORMATION - the details
On July 8, Community member Stugots made the following trades:
Opening trade at 10:57am: Sold short 100 shares of LUK at $43.39
Closing trade at 3:00pm: Bought to cover 100 shares of LUK at $44.35
Maximum gain: $43.39 (entry price)
Maximum loss: theoretically unlimited
ALL-STAR COMMENTARY
I read Stugots' trade notes on a short sale of LUK, and I thought this might be an opportunity to discuss trade entry points. In his trade note, Stugots makes one comment: "bad". I asked him to elaborate and he responded: "bad idea bad stock bad trade bad timing just plain bad." When I looked at LUK I didn't think that it was all that terrible an idea to be bearish on it. Below is the chart on July 7, the day before Stugots entered the trade.
This certainly looks bearish. It has gone from around $57 in mid May to $43.55. So why not just jump in and go short? Well this can be like "trying to catch a falling knife" - very hard to do without getting cut. LUK is dropping fast but odds are that it will rally from the drop at any moment, even if it continues down after that. Stocks usually take little rests (or corrections) from whatever trend they are in. These are often called ‘pullbacks' when the trend is up and ‘bear-rallies' when the trend is down. Even as hard as this one is falling, we can identify a few of these rallies.
Click here for a larger image. (Image 1)
If we had entered short just before any one of these small corrections, we might have gotten stopped out of what would otherwise be a very good trade. Since we have no way of knowing when a down-trending stock might take a rest, you can often increase your odds by waiting for a bear-rally before entering. Of course this takes great discipline because it's hard to watch a stock drop like that and not jump in. What often happens is we wait until we can't wait any longer and finally we jump - just as the stock is reversing a bit. It seems like I have become an expert at figuring out exactly when a trending stock will change course. All I have to do is jump in and that pretty much guarantees it will happen. Maybe some of you feel like you have that ability as well.
So to increase our odds of success we want to wait for a bear-rally and then enter when the stock returns to its downtrend.
Let's see what happened on July 8, the day the trade was entered:
Click here for a larger image. (Image 2)
As you can see Stugots has the same talent. He sold short in the morning at $43.39 and got stopped out at $44.35. To keep from getting stopped out that day, the trigger would have had to be over $45.29 and even higher the next day.
So let's see where it went after that:
Click here for a larger image. (Image 3)
We had a small bear-rally but LUK continued on its downtrend. It has been as low as $41.15 so far. If we look at the entry of $43.39 compared to the low of $41.15, and a continued downtrend, this doesn't seem bad at all, except of course the trade was stopped out on the first day. However, if he had waited for the bounce before entering, he may not have gotten stopped out, even if he had to wait a couple of days to enter.
For the support and resistance fans, here is a longer look at LUK:
Click here for a larger image. (Image 4)
As we can see, there was a possible support level near the entry on July 8. This may increase the probability of a bear-rally before it can continue down. If it does break the 44 level, the next potential target is around $40, based on the previous low in January.
So stugots said: "bad idea bad stock bad trade bad timing just plain bad." Well I don't think it was all of that. LUK still isn't showing much strength, so maybe the stock and the idea were OK. Bad timing is something that can definitely be improved.
I hope understanding how many stocks behave will help you to reduce the number of times you are stopped out. Monitoring the bear-rallies during downtrends (and pullbacks on uptrends) should help you to optimize your trade entry points.
"Income Trader"
Doc's previous posts: Are Repair Strategies Worth It? and Managing Credit Spreads
For a list of previous All-Star Trades, please click here.
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Options involve risk and are not suitable for all investors.
Please read Characteristics and Risks of Standardized Options.
Any strategies discussed and examples using actual securities and price data are for educational and illustrative purposes only and do not imply a recommendation or solicitation to buy or sell a particular security or to engage in any particular investment strategy. In reading content in the Community, you may gain ideas about when, where, and how to invest your money. Although you may discover new ideas or rationale that may be compelling, you must ultimately decide whether or not to put your own money at risk. Consider the following when making an investment decision: your financial and tax situation, your risk profile, and transaction costs.
Jonathan F. Maher, PhD has a professional business relationship with TradeKing.
