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Trading Methodology
We provide commentary geared toward many different trading
styles and have taken the time to bring together a variety
analysts, each with their own unique style and strengths.
However, there are some general rules that we follow for almost
all of the trading ideas you will see.
We typically use the same patterns, apply similar principles of
money management and utilize stops to limit our risk.
Patterns
There are three basic chart patterns that characterize most of
our ideas, each with bull and bear complements.
1) Overextension Plays: Fades and Bounces
We are talking about situations when a stock simply goes too
far. When that happens, an overextended stock loses momentum,
and our analysts look to exploit the exhaustion by taking the
tposition in the opposite direction.
Other times, such a move hits a key support or resistance level
and gives us a churn zone (high volume with little or no net
movement) where we look for the snap-back.
While there are many factors involved in identifying
overextension, it is often a confluence of such factors that
signal the end of an exaggerated move a critical price level,
changes in volume, the appearance of a particular chart pattern
associated with reversals, and various indicator readings. To
utilize those factors, traders will depend upon information
gleaned from various time frames (usually a combination of a
daily chart, a long intraday, and a short intraday).
One classic overextension example is a fade called a Gap Up
Reversal play. It occurs when bulls have lifted a stock well
above a sustainable level in pre-market action. When the initial
excitement subsides, a round of profit taking ensues into which
there is a shorting opportunity. For an in depth look at a fade
play, check out the following sequence:
1,
2,
3.
In the opposite example, there are bounces. Say a news event
hammers a stock lower intraday. As with most market events,
price is subject to crowd psychology: the market overreacts and
the stock plunges through tripwires of long-side stops, taking
out bulls all the way down. But at some point, the storm passes
and rationality returns. At this stage, price is sitting in an
elastic sling stretched too far below a sensible level. It's a
classic bounce setup and an opportunity to go long for a short
time period.
2) Breakouts
Any time you see a level get taken out, it's a potential
breakout play. The breakout occurs when demand or supply are
overwhelmed by its counterpart. The best plays occur when the
levels beyond the battlepoint have not been tested in one
direction, but have been explored fully in the other. For an in
depth example of the breakout play view this sequence:
1,
2,
3,
4,
5.
There are many different classifications of breakouts. But one
we tend to employ often is the Triangle.
The Ascending (bullish) triangle and the Descending
(bearish) triangle are both known as reliable patterns,
especially when the triangle corresponds with the direction of
the overall market.
The Ascending Triangle (top-line is horizontal, bottom line is
rising) is the bullish triangle pattern. The stock has a level
of resistance that it cannot penetrate, but, as it is pushed
back, it continues to show the fortitude and conviction of the
bulls through its higher lows. At some point usually between the
second and fourth test the stock breaks through the resistance
and pops.
Click for an example of an ascending triangle.
The exact opposite is the Descending Triangle (top line is
falling, bottom line is horizontal). The stock has a level of
support that it cannot penetrate, but it continues to butt up
against the resistance line, showing the fortitude and
conviction of the bears. At some point, the stock breaks through
the support and tumbles.
3) Retracements
Last but not least, we often use Retracement patterns as setups.
Following its initial explosion out of a base, a stock may need
a breather (which we highlight in the fades and bounce plays). But
after the stock has corrected the previous advance i.e., after a
round of moderate profit taking, the stock is often ready for
another extension.
View this chart for an example of a retracement play.
These plays have two important keys to keep in mind:
First, the correction should show that (if we are looking long)
there is an abundance of demand, even as the stock quiets
through the correction (i.e., profit-taking does not suck the
stock back down from its new levels).
Second, the retracement should not spike up and check levels
above the original top in the process of flagging. Such moves
demonstrate a lack of participants ready to play the break-out.
If the pattern remains intact and meets our requirements, we use
Fibonacci retracement levels (classic retracements of roughly
38%, 50% and 62%) and volume to give us clues as to when to pull
the trigger.
Money Management
Even if you pick winning trades less than half the time, proper
money management can result in substantial profits. The trick is
letting cutting losses short, and letting the winners run.
While losing money is part of the game, our goal is remind you
to employ strategies that will maximize your gains while
minimizing your loses.
Remember that BriefingTrader is an idea generation
service. That means you are responsible for execution. Make sure
that you are familiar with the various styles and the
different types of information presented on the site before
committing yourself to a trade.
Money management involves never risking more than you are
willing to lose. We suggest keeping positions small, exposing no
more than 3-5% of your total trading capital to any one
position. That way, one bad trade will not put you in a position
from which you cannot recover.
And while we suggested letting the winners run, there's a smart
way to go about that. Never let a winning position go into the
red. That means adjusting stops on trades on which you are up
significantly to at least the breakeven point.
We try to be conservative with our trading suggestions and
generally look for solid risk/reward ratios, usually of 1 to 3.
And very rarely pyramid. More often than not, one should
consider scaling out of position as they begin to produce,
rather than scale in.
And if we may offer a suggestion, don't feel rushed into making
a decision based on the amount of information on the site. Be
comforted by the fact that there are plenty more potentially
profitable ideas on the way. So there's no need to chase a
stock, or one particular idea.
In coming months, we plan to tackle additional money management
topics via our LEARN comments.
Stops
At the onset, an idea is simply a thesis. And a stop is where
the market proves our thesis wrong. The stop may be adjusted in order to preserve
capital as the stock rises and is usually set under an area that would represent a
significant area of resistance/support. The stops suggested intraday
will be tighter than stops for position trades as the scale
has been adjusted to the different time frame.
In general, we suggest using a stop with every trade. Our
analysts suggest logical stop levels based on
support/resistance levels on most every idea they forward. We
feel that stops, when accompanied by proper money management are
two of the most important keys to trading successfully.
For those traders who are particularly risk averse, may we
suggest following RangeTrader's comments, as he tends to
keep his stops very tight, while maintaining classic 1 to 3
risk/reward ratios.
Additional Notes and Tips
1) You will always have a bias. When watching a stock,
you will, at any given moment, have some sense of which
direction it is waiting to go. This bias may change (it should
change) as new evidence of the supply/demand picture comes to
light. But, at any one moment, you will still have some
directional notion in mind as you consider a play. It is good to
identify this bias and only trade with it. The most important
factor in your success is conviction. If you do not have
conviction, you will get shaken out with the weak hands, and be
forced to sit in futility as it goes without you.
2) When approaching a play, try to imagine you are
already in the stock in the opposite direction. When going long,
imagine what it would feel like to be already short that same
name. In this alternative version of your trade, would you be
wanting to get out? If the answer is yes, then you may have a
good long trade on your hands.
Why? Because there are plenty of people who will be trading the
flip side of a coin. Their exit transactions will join your
entry and give you a pop right from the gate. Most of the
patterns described above function according to this logic.
Thinking of the flip-side will help you to understand many
patterns you see, and why they occur.
Consider the double-top reversal: Longs who are still holding
after the retracement remember the paper profits that
disappeared after the high was hit the first time around. So,
when they get back to those levels, the moment they see any hint
of weakness, they pull profits. This is when we look to execute
the short.
3) Don't prejudge the effect of news or fundamental
events. The only thing that matters is supply and demand. So
don't sit there and bang your fist against the keyboard, telling
the market what it should be doing. Focus on what it is doing.
If there aren't any buyers, then it will go down. Often times,
the best trades come in situations when you realize that a stock
isn't reacting with strength on strong news. This is your clue
that the stock is functioning with a deficit of demand. Keep it
on your radar. When the market pulls back, it will almost
certainly show disproportionate weakness.
Contra Warren Buffett, trading is analogous to a beauty contest
where you are best served by judging the judges, not the
contest. You will make money on trades, not by picking the most
beautiful contestant, but by figuring out who everyone else
thinks is the most beautiful. Estimate the judges' judgment, not
the beauties' beauty.
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