Strategy:“Two-day” breakout Market:Stocks
Entry:Go long (short) on move .3 to .5-points above (below) whole number closest to previous day’s high (low).
Exit: Exit with trailing stop or on close.
Risk control:Stop-loss of no more than 0.4 points. Trail stop at this interval if market moves in direction of trade.
technique.
1. Define the day’s breakout and breakdown entry levels before each mar-ket open. Set up one of your trading screens to plot a single, large two-minute candlestick chart covering two days (today and the previous trading day) of trading activity, as shown in Figure 1.
Make sure you start charting by 8:30 a.m. so you can spot any pre-market top or bottom formations, price gaps and trends. Identify the previous day’s high and low.
2.Enter 0.3 to 0.5 points above the pre-vious day’s high (for long trades) or low (for short trades).
3. All intraday trades should have a maximum stop-loss of 0.4 points.
Combined with entering 0.3 to 0.5 points above the previous day’s high, this pro-vides an excellent risk management tool.
In effect, we will exit if the reason for the trade is negated, i.e., the stock moves
back into the trading range near the whole number and the entry price level is violated.
4.Trail the stop to protect profits.
5. Because the market often reverses around 10 a.m. each day, it is useful to tighten the stop during this time to three or four “spreads” (the colored bands of bid and ask levels on the Level II screen) behind the current inside bid. With deci-mal trading, this allows active traders to keep even tighter stops than was previ-ously possible.
Trade examples
Figure 1 shows that on April 27, Ebay (EBAY) made a high of 48 and a low of 45.5. Based on the guideline to place the entry points 0.3 to 0.5 points above or below the previous day’s high and low prices, on April 30 we set long entry at 48.5 (0.5 points above the previous day’s high of 48, which was a whole number).
ACTIVE TRADER • September 2001 • www.activetradermag.com 35
A buy signal occurs in EBAY when the stock moves .5 points above the whole number nearest to yesterday’s high.
FIGURE 1 BUY SIGNAL
9:30 10:00 10:30 11:00 11:30 12:00
4/27/01 4/30/01
Buy signal is generated when price exceeds previous day’s high +.5 points.
Source: Data Broadcasting Corp.
EBay Corp. (EBAY), two-minute
Glossary
Time and sales:
The real-time, official record of executed trades (as opposed to bids and offers) throughout the day. Most trading platforms include a time and sales window to monitor this activity.
Noise:
Random, meaningless price fluc-tuations that can knock traders out of the market.
Buy programs (program trading):
Computer-based trading
approach whereby institutions or large trading operations execute large volume in related markets to take advantage of discrepan-cies between them (i.e., buying S&P stocks and selling S&P futures). See “Program trading and fair value,” Active Trader, Jan./Feb. 2001, p. 28, for more information.
Uptick rule:
Securities and Exchange Commission rule that requires short sales to be executed when the last recorded price in a stock is higher than (or equal to, depending on the circumstances) the immediately preceding price.
(The rule varies slightly for NYSE and Nasdaq stocks, although the principle is the same.) See “A walk on the short side,” Active Trader, July 2000, p. 32, for more information.
We trailed a stop no more than 0.4 points behind the current price level. In this trade, the trailing stop was triggered at 49.375, yielding a net profit of 0.875 points in less than 20 minutes.
Figure 2 (left) is an example on the short side of the market. Adobe (ADBE) traded between 42.4 and 45.4 on May 2.
The next day (May 3) we therefore looked to go short if the market fell to 41.6, 0.4 points below the whole number (42) closest to the previous day’s low.
However, ADBE gapped down to 41.6 in pre-market trading. When this hap-pens, it’s a good idea to move the initial entry point farther away from the price action to avoid being caught on the
wrong side when the market opens.
Therefore, we adjusted the entry to 41.4 to clear the gap with as small a distance as possible. This is not an exact science.
Sometimes you will jump into a trade too soon despite this step; other times this precaution will save you from tak-ing an unnecessary loss.
Because of the uptick rule, it may take several attempts to execute a short trade.
Don’t be afraid to hit the short button on your trading platform software several times (assuming you are using a direct-access broker) so you can get in on an uptick. Check your trade confirmation window to make sure you are executing a single short trade, and not mistakenly
entering multiple trades.
Because the stock already has traded at or close to this price in the pre-market, it also is important that the time and sales window confirms large block trades are going our way and that most trades are being executed at the bid price (indicating selling pressure).
After the entry at 41.4, we trailed a stop a few spreads behind the open trade, without exceeding the 0.3-point stop we’ve set for this trade. Note that the stop is slightly tighter in this trade than in the first example. Because of the support-resistance level created by the pre-market gap to 41.6, this trade will be invalidated as soon as the market trades above this level, which will happen at 41.7 — 0.3 points away from the entry price. Most trades entered before 10 a.m.
should not last any longer than five to eight minutes. Trades entered after 10 a.m. can last a little longer, but never more than 20 minutes. This trade was covered at 40.75 for a .65-point profit.
Bottom line
Successful trading is much more difficult than it first appears. It requires a long process of market watching and practic-ing chart pattern recognition. In time, you can learn to avoid low-potential sit-uations and focus on entries based on specific chart pattern breakouts and breakdowns.
Planning ahead to trade breakouts should be done daily using the previous day’s high and low to set trade alerts.
Trading with the trend on breakouts using these criteria will help traders avoid over-trading and selectively trade the strongest and most powerful chart patterns.
The only exceptions to trading break-outs of the previous day’s trading range are those rare occasions when a stock makes a rapid multi-point drop from the previous day’s high and bounces off the previous day’s low. But this is a trade for experienced traders only, and you should not expect to capture more than 50 percent of the retracements following the bounce.
In fact, buying bottoms and shorting tops is largely a failing method, despite the amazing predisposition of most new traders to attempt these types of trades.
Your trades should be at least 80 percent breakouts and no more than 20 percent bottom bounces, not the other way around.
It’s a good idea to tape that to your monitor, along with the words, “Tight stops — no exceptions!”
36 www.activetradermag.com • September 2001 • ACTIVE TRADER
ADBE had already reached the pre-determined entry price in pre-market trading. The stock kicked off the official trading session with a two-minute rally. Had we sold immediately on the open without adjusting the entry price to take this price action into account, we would have been stopped out with a loss.
FIGURE 2 SELL SIGNAL
9:30 10:00 10:30 11:00 11:30 12:00
5/2/01 5/3/01
Adobe Systems Inc. (ADBE), two-minute