HOW WE DETERMINE TO TAKE A TRADE (or not):
It is rare we take short positions in bull markets. This isn’t because we do not feel comfortable doing so, but rather there simply is not near as many opportunities to do so when inside a bull flag – logically that makes sense. However, occasionally, an opportunity arises and like all trade set ups, if it is there – we take it. We do not pick or choose which ones are ‘better’ based on anything other than price action.
Today, one of those opportunities appeared on our scans. So, I thought it would it be a good time to share with you our process and trade plan for each and everyone of the stocks we purchase (or short sell).
1. We scan for the stocks, in this case we were looking for reversal of trends (w/specific criteria that I will not get into here).
2. $SCTY and various others appeared on the scan as showing potential for a trend reversal. After we get a smaller list from the scans, we write those down and nail it down further from there by asking these types of questions:
- How much risk is involved?
- Where would the stop need to be?
- When is the earnings date?
- What do the other stocks in the sector look like? Are they confirming the pattern we see or not?
3. After we answer the above questions, if a stock is left standing it is going to be sold/bought. The chances of a stock making it through the scan, the questions, the risk to reward analysis and the intense scrutiny we place on our stocks is slim to none. But some, some make it through.
4. Finally, we determine how many shares to purchase or sell and then place the order.
THE TRADE SET UP FOR SHORTING $SCTY:
Now, in the case of $SCTY today I would like to go over, quickly, how we determined a favorable price pattern in this stock (this analysis does not include the above questions as those are usually answered within our heads).
Right after we see a stock on a scan that we like we pull it up on the big chart screen (on another monitor).
After this we take all the indicators off the chart so all we are looking at is price. We do this so we can see, without any distractions, what really matter and that, is price.
From there we start adding indicators back. We usually begin with the 50 sma or 21 ema (simply a preference, nothing special about them). See chart below to see what we are looking at from the start.
Next, we add the moving averages back to see how far extended (or not) it is from the the average price. We did not use the 21 ema in this case because it has become irrelevant based relatively flat slope of it (not shown). However, the 50 sma still has a solid slope to it so we pulled that one up and immediately saw that $SCTY had tested it three times in the past four trading days. This is a lot of tests of one support level and the more a level is tested, the less significant (and weak) it becomes. See chart below:
After we determine price is one, not extended and two, probing a support level multiple times (signally potential further weakness) we take away the moving averages. Next we add bollinger bands to our chart, nothing else. The reason why we like to incorporate bollinger bands into our analysis is we like to visually see how ‘tight’ (contracted) price truly is. The ‘tighter’ the price consolidation, the more explosive the next move will be (usually). In the case of $SCTY, as seen below the BB’s are pinched, signally a tight consolidation. See chart:
If and only if the stock passes the extremely intense scrutiny of our chart analysis will we then take a position in the scrutiny. To take a position we use a formula to determine the correct size (read more about that here: http://www.bencbanks.com/my-strategy-edge-process/).
As for $SCTY, it passed all the criteria and therefore we took a short position in it. The stop is above 72.30 a little, based on the recent pivot high that came in at today’s highs (8/27/14).
We have no idea if this trade will work, we have no idea if $SCTY is going to crash or fall at all. We know nothing in regards to any of that. All we know is that our risk is defined, it is a pattern we recognize and that’s all you can ask for.
Please feel free to shoot me an email (via Contact Page) if you have any questions or comments. Hope this helps some of you.