Tuesday, April 22, 2008

Excerpt from (what will be) today's newsletter

The market was weak today but we had two good runs: VLO from the watch-list, and DRYS from the trading-list. FSLR, unfortunately, gapped above our number.

The DRYS trade encompasses several lessons that are constant in our system, so let's go through it in detail.

1) Volume and relative strength were excellent. Volume was around 40% of daily in the first hour and stock was near highs as market was near lows.
2) Notice how DRYS gapped up and held the gap, even though the market kept going lower into the red zone.
3) Base and break 1 point under the daily resistance at 77. This was entry: buy on break of 77 with stop on any reversal.
4) Don't forget how often our stocks set-up exactly 1 point under the spot in a base and break pattern.
5) Always buy from the break of the base (low slope) and sell into vertical rise/spike (high slope). At 77 the stock is just breaking the flat base; at 80 the stock is vertical.

When we saw DRYS gap-up with volume we started feeling confident that the stock would go today. When the market started going into deep red zone and DRYS stayed green, we grew more confident. We bought an initial position just over 77, added two times between 77.3-77.5 when it became clear to us that the stock was going to make a run for resistance. In the first spike towards 78.5 we started peeling off the position, sold more into 79, and exited on the reversal below 79.5. We contemplated buying back the position around support at 12:40 P.M. but didn't.

Trader's Segment:

One of our readers sent in the chart of the trade today. Let's take a look:

R.S. writes: "Since the sector was strong I decided to gradually scale into DRYS. I waited until I had a nice profit on the 1st buy; then made the 2nd. As it traded through 78, I loaded up and then sold on the first red candle. I've been tempted to get back in BUT I've learned to be happy with my profit and WALK away."

This trader bought an initial position into the base and break and added as the stock went through resistance. We wrote in this weekend's newsletter how "In moves that we think are significant, for example, a sector break-out, we are often more patient in taking profits and actually add as the stock starts to run." and this is exactly what this trader did today. Instead of selling into 78 (which would often be quite logical as the stock is becoming vertical) R.S. actually bought more. Why? Because of the fantastic volume and relative strength coupled with strong sector strength. There was also no fear as there was an already comfortable margin of profit (since initial position was from 77) from the initial base and break buy.

This is the reason why we write that exit strategies are often nuanced. You need experience in the market and to know when to not push your luck, and when to have conviction that the stock will run hard. Note that this was a very aggressive trade, and one that cannot be done in less benign environments (where we would recommend to sell into the number instead of buying more). All in all, an excellent trade.

VLOVLO knocked on our number (54) several times before breaking it and going up exactly 1 point. Recall this weekend we spoke about exit profits, and how we like to take off profits at 1 point intervals. We weren't crazy about VLO intraday as the number kept being hit, something that increases the risk of sudden reversal. Nevertheless it worked well for a nice and easy point.

Both DRYS and VLO moved quite fast and were easy to miss if you were watching many stocks. This is the reason we always write that you should focus on the best daily spots, usually around 10-12 stocks per day. If one stock has early volume (look at volume % in QT) then stalk that stock specifically. One of the biggest mistakes of new traders is watching too many stocks. They don't do any research the night before, run scans, and watch hundreds of stocks hoping to catch the move. They end up jumping on the move too late and find the stocks reversing on them immediately.

Make every trade a good trade, be it for a loss or profit; this means that every trade you take should be from a valid set-up. If no valid set-ups appear during the trading day, then sit aside.
Absolute key to this system is to be in control of your emotions, have enough experience and knowledge to differentiate between good and bad set-ups, and then to develop the patience to wait for the valid set-up instead of trying to trade constantly.

Don't be the panicked, frazzled, anxious noob jumping from one trade to another. Be the calm, rational trader who crouches in wait, and then leaps to the occasion as the stock breaks the base. In our opinion, the system of waiting for daily spots plus defined intraday set-up of buying off the base on stocks with good volume and relative strength, is one of the most consistent methods out there for making a living in this business.