Dedicated to @daytrend who motivated us to write a post on how we buy support
We do two types of knife catching, one is in long-term account, and one is in our more active day-trade/swing account. The long-term account is mostly inactive and probably used only a few times a year with the monies in safe but low interest money markets. In the long-term account absolute key is to not even start the first buys until it's chaos-panic out there. For example today was the first buys we made in this account -- sitting out already a move down from 122 to 108 SPY. We put on our first 20% positions today. We only enter 20% max in one day and only on next areas of support (next buy comes at SPY 105 or lower which would take us only to 40% invested). Almost always these buys are in commodity stocks we believe in long term and never in fad stocks (TASR CROX two good examples). There is no time-frame for this account and we never use margin -- these are long term holds for the future on the belief that commodities like oil are finite, the world population is growing, and that eventually demand will re-appear. The stocks we started buying today were SU JRCC USO RINO ATPG MOS TC MON AA CAGC VALE AKS. All broken charts, horrible looking, but also very oversold and good candidates for long-term holds.
The other, and probably more interesting to most of you, type of knife catching is what we do quite often in our day-trade account. It's not really knife-catching since we wait for buyers to show up near support (or on overshoot strategy if no set-up on support), buy after stock has started to reverse with stop under. Risk is always defined because you have your stop before you even enter (as opposed to what we do in our long-term account) and it often works well. In fact our best days often come not from break-out days but from buying the panic. It's our specialty (and we pray to the market gods not to curse us after that last sentence). We've done numerous trades like this in real-time just in the last 5 months since we joined Twitter.
So what do we look for?
1. Divergences, what we've called "comparative analysis" over the last few years. We always look for "tells" to start diverging. If crude has been leading market down we look for it to first stabilize. Financials are another sector that often serves as a great tell. If market is going to hell but financials are making higher lows then that's often a good tell for a market bottom (and remember these are day-trades, we're not looking for a 3 month bottom, but sometimes just a quick 1 hr bounce).
2. Absolute key is to wait for the reversal before you enter and put the stop under. Sometimes it's very volatile and if we wait for a 5 minute candle to close we have to place a stop over a point away, something we don't want to do. This means that often we go in on what we perceive is the bottom but before the candle actually closes. When we're wrong on these trades we get stopped out literally in seconds. If you don't trust yourself to take a stop instantly, and sometimes it means losing $1000-$2000 in 30 seconds, then don't try it because that realtively small 1-2G loss could snowball and blow out your account 30 minutes later while you're still frozen in shock. If you're the type that freezes, then forget about support buying and just stick with trend-trading.
3. We don't start entering until the stock is extended from the 20EMA/5 minute but near daily support. This is key -- we enter when daily and intraday are both extended. Daily alert will already have been chosen from the night before as oversold stock heads into daily support. Intraday we look for stock to move away from 20EMA/5min in a panic slope down. Then and only then do we enter when reversal has already started with a stop on the low. Our first target to take a partial position off is the EMA itself. We're also very quick to move stop up to break-even after taking off the first load.
4. Intuition. We've made a science of it and have numerous posts on the subject but in the end you need the screen time. It's much harder than it looks and you need experience to make it work. We've traded for over 13 years through some brutal markets and have earned our stripes the hard way. We can offer insight into our experiences and show you how we do things, but in the end, you have to do the grunt work and earn your badges.
This is a very quick summary and might seem confusing if you have not followed our strategies over the years but the following posts go into detail of everything we just mentioned. Many of them include screen shots of our real-time calls plus charts to illustrate these strategies.
Buy first test, short the second
EMA strategy for buying support
How to Daytrade Support
USO support Trade
Overshoot Strategy, real-time