TOP 10 TRADING SETUPS
How to Find them,
When to Trade them,
How to Make Money with them
@Ivanhoff
www.rasabourse.com
TABLE OF CONTENTS
INTRODUCTION - The one thing that will make you a better trader.
Chapter 1. BREAKOUT SETUPS – How to profit from range expansion.
Chapter 2. PULLBACK SETUPS - How to enter an established trend with
low risk and for high reward.
Chapter 3. IPO SETUPS – How to find stocks that can go up 50% in a
month.
Chapter 4. INDUSTRY MOMENTUM SETUPS – How to benefit from one
of the most powerful market forces.
Chapter 5. EARNINGS GAP SETUPS – How to profit from post-earningsannouncement drift.
Chapter 6. SHORT SQUEEZE SETUPS – How high short interest might lead
to explosive short-term moves.
Chapter 7. HUGE VOLUME SETUPS - How to quickly grow a small
account.
Chapter 8. BEARISH SETUPS - How to make money during corrections.
Chapter 9. RELATIVE STRENGTH SETUPS – How to gain from the moves
of big players.
Chapter 10. MEAN-REVERSION SETUPS - When is the right time to go
against a trend?
Summary
About the author
Other books by the author
Disclaimer
Copyright
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INTRODUCTION
The one thing that will make you a better trader
“The market plays the music. How you dance depends on the music played.”
- Brett Steenbarger
They say that the definition of insanity is doing the same things over and over
again and expecting different results. If you do the same things over and over
again in the stock market, you are guaranteed to get very different results. Do
you know why? Because the market is constantly changing. This is the big
secret of financial markets. Nothing works all the time.
Different setups work in different markets. Everyone makes money in a bull
market. Not everyone keeps it when the market goes into correction or a
range-bound, choppy mode. A good trader is able to adapt to changing
markets.
Many get into trading with dreams of getting rich quickly and becoming
financially independent. The problem is that most expect things to happen
immediately. At the beginning of their career, most people are
undercapitalized and have no idea what they are doing. When you are
undercapitalized, you are likely to do at least one of the following five major
mistakes:
trade too big,
trade without an edge or in other words - gamble,
overtrade,
trade low-priced junk stocks,
use excessive leverage.
Some say that discipline and risk management are the solutions to all trading
challenges, but they are not going to help you if you trade a setup without an
edge in the current market.
Discipline + A losing setup = Consistent losses and frustration.
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The one big thing that can improve your trading life is learning how to
recognize changes in markets and being able to quickly adapt to them.
Different setups work in different markets. Knowing what works and what
doesn’t work in each environment is 80% of the battle.
There are four major types of markets and each of them requires a different
method: Uptrend, Range-bound, Downtrend, and Bottoming Process. On
these pages, I share my approach to each of them.
There are six main factors that have the biggest impact on stocks’ price action
in a short-term perspective:
the general market direction,
price momentum,
industry momentum,
float and newness - is it a recent IPO,
market reaction to a recent earnings surprise,
and short interest.
In this book and in my personal trading, I focus on setups that have at least
two of the above-mentioned catalysts going for them.
This is one of the most practical trading books ever written. It doesn’t waste
your time with personal stories of grandeur. It is all about setups. I explain
what setups to trade and when, why they work, how to find them, how to
trade them, where to exit. It is a complete game plan for any market
environment.
And since I believe a good picture is worth a thousand words, there are 140
annotated charts with examples for the ten major setups discussed in the
book.
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Chapter 1
BREAKOUT SETUPS
How to Profit from Range Expansion
When the general market is rising and a stock is in an uptrend, nine out of ten
times it is better to look for a place to enter on the long side rather than a
place to go short. There are three basic ways to enter a rising stock:
a) On a breakout from recent consolidation – we buy on the day of the
breakout or on the next day and put a stop under the consolidation.
b) Buy somewhere in a sideways consolidation in expectation of a breakout –
this is a smart strategy in a bull market when almost all good-looking
technical consolidations eventually break out, but a terrible strategy in any
other market.
c) Buy a pullback to a rising 10-day, 20-day or 50-day exponential moving
averages.
In this chapter, I focus on breakout setups.
The setup
Price > $1
4% breakout to new 20-day highs
Average daily traded volume > 100k shares
All major market averages are in a confirmed uptrend
Range contraction above 10 and 20-day EMAs (exponential moving
averages)
Why a 4% breakout from tight range consolidation to new 20-day highs?
Expansions in daily price ranges often start new trends. This is a concept that
you can apply on different time frames - intraday, daily, weekly. Four percent
is a big enough move to potentially start a period upside momentum. It only
works in rising markets.
What are the likely results after a breakout?
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1) Immediate follow-through – many breakouts don’t have an immediate
follow-through. They don’t just go up 5-10% for four to five days in a row.
Most stocks are messy after their initial breakout and have some intra-day
pullbacks, which shake out impatient traders, who are looking at every
downtick.
2) Tight-range consolidation on the next day, usually in the upper part of the
breakout day range. Then it continues higher on the third day.
3) Spends a few days of tight-range consolidation – it could pull back to a
rising 5dma or longer-term moving average for larger cap stocks. Then it
continues higher.
4) Pulls back below the lows of the breakout day or in other words – it fails.
The main factor that improves the odds of having a profitable breakout trade
is the current market environment and industry momentum.
How it works
Most stocks go up in bull markets. We need to take maximum advantage of a
good bull market and focus only on stocks that are moving.
Even in a bull market, stocks don’t just go straight up. Stocks spend only
20% of their time trending. The rest of the time is range-bound noise with
very few opportunities for traders to make money. This is why we wait for a
breakout from a range contraction period before we enter.
When to trade this setup
It works best when all major market averages are in a confirmed trend. Small
caps (IWM), mid caps (MDY), and large caps (SPY, QQQ) are trading above
their 50-day moving averages. Also, it helps if small caps (IWM) is trading
above its 10-day EMA.
Breakouts don’t work in range-bound and corrective markets. In fact, you
will probably lose money trading breakouts during those markets.
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The good news is that the market is usually hot at least a couple times a year
for a few weeks, even in the most bearish market years. Learn to recognize
those periods and take a full advantage of them by trading this setup.
When to enter
We buy on the day of a bigger than 4% breakout to new 20-day highs as soon
as the stock appears on your scan.
Where to put your stop
You can put your initial stop half a percent below the lows of the entry day or
right below the 10-day EMA (exponential moving average).
Position sizing - how much to risk and how many shares to buy
Risk is usually 1%. On 500k trading capital, 1% risk is 5k.
Let’s say you want to buy Advanced Micro Devices (AMD) at 4.10 with a
stop at 3.80. Your risk per share is $0.30.
We divide the total risk per idea of 5k over the risk per share of 0.30 to get
the number of shares we can afford to buy. In this case, 15,666 shares.
The total capital allocation would be: 15,666 * $4.10 = $64,200, which is
about 13% of your capital.
Exit
Sell half two to five trading days after your entry. Sell the rest on a close
below a 10-day EMA.
How to find this setup
You can apply the above-mentioned screening criteria in Finviz.com.
Context
People have issues with trading breakouts for four main reasons:
1. They trade the same setup in every market expecting similar
results. Markets don’t work that way. Markets change all the time.
Different setups work in different markets. For example, breakouts
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work amazingly during rising markets, but they will lose you
money during range-bound, choppy and corrective markets. When
your bread and butter setup stops working, you have two options –
find a setup that works or sit on the sidelines until market
conditions come back in your favor.
2. They expect to be right almost all the time. This doesn’t happen,
even in a bull market. Having a 50% success rate is a very good hit
rate. Think about that. If you can be profitable only 50% of the
time, how big should your losses and gains be in order to achieve
great returns? Not taking a small loss and letting it turn into a big
loss has many consequences. The impact on the mind can be even
worse than the impact on your account. A big loss influences your
future position sizing - you trade small when you have to trade
bigger because you are scared. A big drawdown can impact your
objectivity and ability to spot and take great setups.
3. They expect regular income from trading. It doesn’t work this way.
Periods of making a lot of money are followed by periods of
making no money and periods of losing money. The goal is to
keep losses to a minimum and be aggressive only during the right
circumstances. Twenty percent of your trades will account for
most of your profits. The rest should be small wins and losses that
cancel each other out.
4. They trade too big. Most aspiring traders are undercapitalized and
they want to get rich quickly. This leads to trading too big, putting
all of your money in one small-cap stock, trading illiquid penny
stocks, trading options directionally. To sum things up, they trade
crappy stocks with a lot of leverage and then they get wiped out
quickly.
George Soros and Stanley Druckenmiller became famous for putting
50% or more of their capital into a single position. People assume that
they can trade like Soros and Druckenmiller and this is a huge mistake.
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Never put yourself in a situation where a small market move could
shake you out of a perfectly good position just because your sizing was
too big. Never let a trade impact your sleep and overall happiness. You
don’t want to be in a position where you own two stocks and they are
the only two that are not moving with the rest of the market. You
should never put more than 20% of your capital into a single stock.
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Examples
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Chapter 2
PULLBACK SETUPS
How to Enter an Established T rend wit h Low Risk and for High
Reward
Once a strong trend is underway, it tends to persist and offer multiple great
entry opportunities for swing traders.
There are two major ways to trade in uptrends:
1. buy strength – breakouts from tight consolidations
2. buy weakness – buy in anticipation of a trend continuation.
Some of the reasons to buy weaknesses in established uptrends:
A) If you miss an initial breakout - keep in mind that some strong stocks
won’t pull back to let you in, especially during bull markets.
B) If you don’t want to chase and you are afraid of buying on strength.
C) If you are looking for a great risk/reward entry - this especially applies to
large-cap stocks, because they tend to pull back after their breakouts. A large
cap is a company with a market capitalization of over $5 billion.
The setup
1. We look for stocks with a very strong price momentum - up more
than 20% in the past month or more than 30% in the past quarter or
more than 50% in the past six months.
2. There is some form of consolidation - either through time
(sideways move) or through price (a pullback to a rising 10, 20 or
50-day exponential moving averages.
3. Price > $1
4. Minimum daily traded volume > 100k shares.
We don’t just buy any weakness in any stock in an uptrend.
1. We make sure the major market averages are in a confirmed
uptrend.
2. We only pay attention to stocks that belong to an extremely hot
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industry or stocks with a very high price momentum.
3. We don’t buy blindly any pullback to a rising 10 or 20-day moving
average. We are waiting for a signal of trend resumption. This
signal is usually a 3% bounce near a stock’s 10 or 20-day EMAs
(exponential moving averages).
Even if all those requirements are met, we will still have some losing trades.
It is inevitable and it doesn’t matter. In a rising market, these types of setups
are likely to have a higher than 50% success rate and the winners are likely to
be 3-4 times bigger than the losers.
How it works
Stocks with established recent momentum are usually under accumulation.
Why is accumulation so important? Because it is a sign of institutional
involvement. Big hedge funds, mutual and pension funds. Most of them are
not short-term traders. They are not looking to flip a stock for a 50-cent gain.
They need time to build a position of proper size. Their trading/investing
horizon is at least several months. They are likely to support their positions at
important technical pivots like a rising 20 or 50-day or 200-day moving
average. This is why many dip buyers look to buy bounces from rising
moving averages. Those types of trades offer low risk/high reward potential.
Sometimes, stocks will bounce exactly near their rising 10 and 20-day
moving averages. This often happens because of a self-fulfilling prophecy. If
enough people believe that it will work and act on their beliefs, then
expectations become reality. Many trend-following algorithms are
programmed to buy dips to rising major moving averages.
Other times, stocks will go below their major moving averages, shake out
many people, and then come back above their 10EMA. Such comeback is
also a strong signal. The markets don’t always conform to the obvious.
When to trade this setup
It only works during confirmed market uptrends. This means that all major
market indexes are trading above their 50-day moving averages which are
above their 200-day moving averages. The four major indexes that I follow
via ETFs are small caps (IWM), mid caps (MDY), and large caps (SPY,
QQQ).
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Buying in anticipation of trend resumption makes sense only with high
momentum stocks.
You can front-run a breakout in a great setup from a strong industry in a
rising market. Sooner or later, all great tight consolidations break out in a
strong market.
When buying dips and bounces in strong stocks stops working, the market is
sending you a message - it has changed. Markets rarely go from being in a
clear uptrend to being in a correction mode. There’s usually a distinct stage of
distribution between the two. This stage is characterized by a choppy, rangebound market action and heavy sector rotation. The best thing to do when
you realize that we are in one:
1. Look for an industry that is bucking the trend.
2. If you cannot find such industry, raise your cash position, reduce
your trading size and become more selective.
Where to enter
There are several ways to enter an established trend in a stock with a strong
price momentum.
1. In anticipation of a breakout - we enter in its range contraction
zone. Sooner or later, most bullish setups break out in a rising
market.
2. Create a watch list of strong momentum stocks and enter exactly
when they are breaking out (making a new 20-day high).
3. Buy a pullback near a rising 10 or 20-day EMA. This is a riskier
approach, but it can be applied as long as you honor your stops.
4. Wait for a 3% bounce from a rising 10 or 20-day EMA before you
enter. Three percent bounce above the previous two days’ highs
might signal the start of a new leg up.
Where to put your stop
Half a percent below the entry day’s low or a stock’s 10-day EMA.
Exit
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Sell half on strength, two to five trading days after your entry. You can sell
the rest on a close below a 10-day EMA.
This is a powerful swing trade setup. The purpose of swing trading is to
capture hundreds of 5% to 20% short-term moves every year. This is why
selling on strength makes so much sense.
Position sizing - how much to risk and how many shares to buy.
Risk is 1% of capital. On a 200k account, 1% risk means 2k.
If we want to buy Paypal Holdings at $41 with a stop at 40, our risk per share
is $1.
We divide our total risk per idea of 2k over our risk per share of $1. The
result is 2000 shares. This the the maximum number of shares we can afford
to buy.
2000 shares x $41 = $82,000.
82k is too big of a capital allocation for a 200k account. I usually keep my
biggest positions to 20% of my account, which would be $40k in this specific
case.
How to find these setups
Scan for the best performing stocks on various time frames - weekly,
monthly, quarterly, 6-month. Pay attention to stocks that are bouncing from
their rising 10- or 20-day EMAs. Also, stocks that are in a range contraction
mode and near 50-day highs. They are very likely to resume their trend in a
strong market.
Finviz.com is an excellent source for these type of screens.
Context
If you are going to dedicate time to learning how to trade, it is important to
know what your strengths and weaknesses are so you can get a little better
every week. One practical way to achieve that is by studying your past trades
every day.
Always ask yourself the questions:
Did the setup I took have an edge in this market environment? If not, why did
I take it?
Was my entry good? Was I chasing or did I entered at a good spot?
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Where was my stop and did I honor it? If no, why did I take it?
What was my exit strategy? Did I exit too early or too late? Is there anything
I need to change in my approach to better adapt to the current market
environment?
Was I physically, mentally and emotionally prepared to trade that week? If
not, what can I change to make sure it doesn’t happen anymore? If yes, what
can I do to repeat it?
The answers to all those questions will highlight your specific weaknesses
and strengths that you need to work on.
Another exercise that can help you grow as a market participant is studying
the best and the worst performing stocks on different time frames. It can open
your eyes for new ways to approach the market. On a regular basis, I study
the best and the worst performing stocks for the past week, month, quarter
and six months and look for common themes. This exercise can do wonders
for you if you do it consistently:
1.
2.
3.
4.
It is a deliberate practice into recognizing setups.
It provides good swing and position trading ideas.
It helps you to spot easier industry momentum.
It allows you to see notable shifts in market sentiment - is the fear
of missing out getting bigger? Is the fear of losing dominating?
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Examples
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Chapter 3
IPO SETUPS
How to Find Stocks that Can Go Up 50% in a Month
IPO stands for Initial public offerings. An IPO is the first time a company
offers its stock to the public. When a company becomes public, its shares are
traded on the secondary stock market, where anyone can buy and sell them.
You will find incredible trading opportunities among recent IPOs. Because of
their small float and institutional support, they tend to move a lot in a short
period of time. Recent IPOs are among the most lucrative trading vehicles in
bull markets.
The setup
Recent IPO, preferably less than six months old.
Price above $5 per share.
Average volume above 200k shares per day.
There are several tight price range days, followed by a breakout. A
breakout is a 4% move that goes above the highs of the most
recent range. Four percent is a big enough move to potentially start
a new trend.
We are either in a strong bull market or in a market recovering
from a recent correction.
Trading close to all-time high prices is a plus in a raging bull
market, but not a requirement. Plenty of new stocks start their big
moves when they are 40-50% from their all-time high prices,
especially right after a major market pullback.
Belonging to a currently hot industry is a huge plus.
A story stock - overhyped company with strong sales growth is a
plus, but not a requirement.
How it works
Recent IPOs have a serious tailwind in a rising market:
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a.
They have a small float, which is a lot easier to manipulate.
b.
Many of the initial shares of a new IPO are allocated to mutual
and pension funds, which are long-term holders. They are not small
hedge funds that are likely to flip their shares a few days after their new
holding starts to trade with some volume.
c.
Many funds that were not allocated any or enough shares during
the IPO, will try to acquire them in the secondary market. When you
have hundreds of funds competing for a small float, prices could rise
very fast.
d.
New IPOs usually open at very high valuations, which attract
eager short-sellers like honey attracts bears. The problem for the shorts
is that there are usually very few shares available to short. A small float
coupled with a high short interest in a bull market is a recipe for a major
short squeeze.
Small float, a bull market, and a good story are an explosive combination.
If you want to understand why IPOs are among, if not the best, short-term
trading vehicles in bull markets, you need to educate yourself on the concept
of float and what it means for supply and demand.
Float is the actual number of shares that is available to the general public.
Float = Outstanding Shares - Restricted shares.
The number of outstanding shares is decided by the board of directors of each
company.
Restricted shares are owned by insiders: founders, management, employees,
VCs.
Companies always sell a minority stake during their IPO. You will notice that
most newly public companies’ float is only 10 to 20% of their total shares
outstanding. The difference is called restricted shares and it is owned by
insiders, who are not allowed to sell for the first six months. This restriction
is not created by the SEC, but by the underwriting investment banks which
are trying to create a stable market for new stocks.
For example, Google offered less than 20 million shares for its IPO in 2004.
The rest became available 6 months after the IPO. Today, Google has a float
of 620 million shares - it takes a lot more buying and selling power to move
this big ship.
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Microsoft’s float was only 20 million shares in 1986. Today, it is 7.6 billion
shares.
In May 2016, Acacia Communications (symbol ACIA) raised $100 million
by offering 4.5mm shares at $23. At the time, ACIA had 35mm outstanding
shares. Its stock gapped to $30 on its first trading day and then proceeded to
double in the next couple months. By August 2016, ACIA was trading near
$120 per share.
In June 2016, Twilio (symbol TWLO) offered ten million shares to the public
out of eighty million outstanding shares. Its stocks ran from $24 to $44 in
three weeks.
When to trade this setup
Low float equals fast moves. This means big upside moves in uptrends and
big downside moves during corrections. It is not a one-way street. It has its
benefits, but it also has its drawbacks. Trading recent IPOs could be
extremely profitable, but you need to know when to trade them.
Trading recent IPOs delivers the best results in two types of markets:
A.
Raging bull markets, when all major stock indexes are trading
above their 10, 50 and 200-day moving averages.
B.
Right after a deep market correction, defined as a bigger than 8%
decline in the S&P 500.
It is normal for the IPO market to close during periods of excessive market
weakness. Investment banks advise their clients to postpone their IPOs in
times of extremely negative market sentiment.
Companies rarely go public during market corrections, because they get very
low valuations. Companies that go public shortly before a major market
correction tend to get a major beating. This creates incredible opportunities
for speculators.
Due to their small float, recent IPOs tend to get hit hard during market
corrections. And by hard, I mean they could have 50% to 90% drawdowns.
When the stock market bounces back, their recovery is often as quick and
furious as their decline. Recent IPOs deliver incredible profits after a market
correction is over. And by incredible, I mean 100% to 200% in 3 to 12
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weeks.
Let’s review the correction in early 2016 as an example.
From January 1st to mid-February 2016, the S & P 500 went down 8%.
There were no IPOs in January. In February, there were five in total. Only
three companies IPOed in December 2015 and they all got hit pretty hard
during the market correction from January to early February. Yirendai
(symbol YRD) was one of them. Their initial float was 7.5mm shares out of
59 million outstanding shares. YRD was absolutely decimated during the
market correction in January. It went from $10 to under $3.50 a share in early
February. Guess what happened after the market started to recover in midFebruary? By April 2016, it was trading near $14. By August, it was trading
near $40 per share. Those low-floaters can move a lot, in both directions.
When to open a position
As a reminder, we don’t just blindly buy any recent IPO. We look at their
charts and search for some form of a range contraction followed by an
explosive range expansion. Contractions can be found in stocks trading near
all-time highs – something very typical for raging bull markets. Contractions
can also be found in stocks trading near 52-week lows – this is a normal
occurrence right after market corrections.
There are two major ways to enter a recent IPO setup:
A.
After a 4% move that takes a stock above its most recent
consolidation zone.
B.
In anticipation of a breakout, only if your stock of interest
belongs to a currently hot industry.
See examples at the end of the chapter.
Where to place your stop
If you are buying during a 4% breakout, your stop should be a few cents
below the breakout day’s low.
If you are buying in anticipation of a breakout, your stop should be about 1%
below the lows of the established range.
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Position sizing - how much to risk and how many shares to buy
You should not risk more than 1% of capital on recent IPO setups. Between
0.5% and 1% is normal, depending on how liquid a new stock is.
Let’s assume that your current trading capital is 100k.
Then, 1% risk per trade means $1000 risk per setup.
If you buy a recent IPO at $12 per share with a stop at $11, then you can
afford to buy 1000 shares. To get to that number, divide your risk per trade of
$1000 over your risk per share of $1. This means that your capital allocation
to this trade is 12% (1000 shares * $12).
If you are wrong, you are going to lose 1% of your capital. If you end up
being right, and, let’s say your stock of interest goes quickly from $12 to $18
- which is not unusually for hot new IPOs - then you will make $6 per share
profit. This is six times your risk per share. Since you risked 1% of your
capital, it means that in this case you will add 6% to your annual return. As
George Soros likes to repeat – “it is not important whether we are right or
wrong, but how much money we make when we are right and how much
money we lose when we are wrong.”
Exit Strategy
It is important to realize that most recent IPO should be treated mainly as
short-term trading vehicles. They are perfect for 3- to 10-day swing trades or
3- to 10-week position trades.
If you are swing trading, one good exit approach is to sell half of your
position on strength, 3 to 5 days after your entry. Sell the rest on a close
below your stock’s 10-day EMA (Exponential Moving Average).
How to find those setups
In theory, the perfect source for finding great recent IPO setups would be an
easy-to-use screener like finviz.com. In practice, such a screener doesn’t
really exist yet. I love FInviz’s option to look at multiple charts on one
screen. It is a huge time saver. The problem with Finviz is that it does not do
a good job updating its IPO database and, as a result, many new stocks are
missing. This defeats the whole purpose of screening for new stocks with
their software.
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MarketSmith.com might offer a better alternative as its IPO database is
updated more often. It is more expensive than Finviz and its user interface
could use some improvement.
Sparkfin is a free financial application that offers thousands of regularly
updated watch lists. Some of those lists are dedicated to recent IPOs.
If you have the time and you are well organized, you could create your own
watch list of recent IPOs by going through the IPO filings on sites like
Nasdaq and Market Watch:
http://www.marketwatch.com/tools/ipo-calendar
http://www.nasdaq.com/markets/ipos/activity.aspx?tab=pricings
Context
There are three major reasons for a company to become public:
a) to potentially get a valuation that it cannot get in private markets.
b) to provide liquidity to employees, founders and early private investors.
c) to raise money to fuel further growth.
If the overall stock market is strong, they belong to an industry that is
currently hot, or have an intriguing growth story behind them, investors will
buy new stocks regardless of their valuation.
Stocks that are trading at 200 times earnings could easily reach a valuation of
1000 times earnings in a raging bull market. There is no logic to short-term
moves in hot stocks with a small float. Fundamentals might account for the
first 30% of the move. The rest is all based on momentum and sentiment in a
weird musical chairs game.
Story stocks tend to run a lot in a bull market. They often cannot be valued
easily and they have huge potential for future growth. They become public at
obscenely high valuations, which attract many short sellers early on. Short
interest turns into fuel for higher prices. A small float combined with a high
short interest in a story stock is a recipe for a wild move. A recent IPO with a
good story could double and triple, and squeeze early short sellers before it
ultimately reverses lower.
Examples of story stocks: GoPro, which went up from $40 to $100 in two
months at the end of 2015. Shake Shack, which went from $50 to $100 in six
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weeks in early 2015. Twitter, which went from $40 to $75 in four weeks at
the end of 2013.
New IPOs can also tell you where the hot action in the stock market is.
Investment banks do their homework. They are sophisticated marketing and
distribution machines and they know what to offer. They know what people
want, most of the time. Once they figure out that a certain industry is
becoming overly popular and in demand, they are very likely to flood the
market with stocks from that industry via IPOs and secondary offerings. No
trend lasts forever. Eventually, the demand is satiated, the supply goes
through the roof, stocks stop moving higher every week, and begin to tumble.
People get scared and everyone runs for the exit at the same time.
If the market is in distribution mode, new stocks don’t belong to a currently
hot industry and there’s no sexy story involved, new stocks will probably get
heavily shorted and eventually lose 50% to 80% of the valuation reached on
day one of their IPOs.
Why should you learn how to trade IPO setups?
A.
B.
C.
Limited universe of stocks to follow.
Easy to understand catalysts.
Potential to move 30% to 100% in a month or so.
A combination of small float, newness, industry momentum, and a strong
uptrend are the perfect conditions for recent IPOs. Sure, you could make the
same argument for any other stock. The difference is in the opportunity cost.
For each 1% you can make in the S & P 500, you could probably make 10%
in a recent IPO from a hot industry. Recent IPOs could move 20% to 50% in
one to three weeks in strong markets. They could double and triple in one to
three months right after 10% market corrections. A bull market should not be
wasted.
It is not unusual to have more than 50 IPOs in a month during strong bull
markets. How can we keep our watch list of recent IPOs manageable? There
are two main filters: volume and price. Fast moving new issues usually trade
over 200k shares per day since the get-go. Many actually trade more than
500k shares a day. Such high volume signifies institutional interest. Then,
you could rank them based on:
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1. Price setup - we look for range contraction, followed by a breakout
that indicates the beginning of a new momentum move. You could
also buy in anticipation if the IPO belongs to a strong industry.
2. Industry momentum - does it belong to an industry that is currently
in favor?
3. Earnings and sales growth.
Find a hot new stock and put it on your watch list. Even if you have missed
its first major move higher, it will likely provide several great trading
opportunities in the first three to six months of its existence.
Organizing yourself to trade IPOs is not difficult. Anyone can do it, but it
takes some effort, dedication, and time. The good news is that the markets is
very strong a few times every year, and during those times some new stocks
could deliver amazing returns.
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Examples
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Chapter 4
INDUSTRY MOMENTUM SETUPS
How to Benefit from One of the Most Powerful Market Forces
Money never sleeps. It always rotates somewhere. Every year, there’s a hot
industry theme that dominates price action and market talk. It could last only
a few weeks or multiple months and provide incredible opportunities for
swing and position traders.
The power of industry momentum will surprise even the biggest optimists. If
you are able to figure out which industries are currently hot, and focus your
trading efforts on them, you will realize that trading can be a pleasurable and
lucrative experience. Risk management is a lot easier if you are on the right
side of the market in the right industry. Why? Because your success rate is a
lot higher and your winners are a lot bigger, the number of failed trades is a
lot smaller.
The setup
1. Find the leading industry.
2. Find the leading stocks within that industry and own them. If you
miss their breakouts, you can buy their pullbacks to rising 10 and
20-day EMAs.
3. Within the currently leading industry, find stocks that are setting
up for a potential breakout. You can buy them in anticipation of a
breakout during strong markets or wait for the actual breakout.
There are several ways to determine which industries are currently leading:
a.
Keep a list of the top performing industries for the past three
months.
b.
Keep a list of industry related ETFs. If you see one setting up for
a potential breakout, dive deeper and take a look at its individual
components.
c.
Check which industries have had the largest number of stocks
with 4% daily gains in the past week.
d.
Find out which industries have the highest number of stocks
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setting up for potential breakouts - look for range contraction and good
risk/reward setups.
Many traders say that risk management is the key to success. It is true. What
many don’t understand is that being in a leading industry makes risk
management a lot easier.
Asking the right questions leads to better answers, better solutions. You can
significantly improve your trading results if you make industry momentum
the starting point of your research. Always ask yourself what the currently
leading industry is.
How it works
Stocks move in groups because the players that move markets think and
invest in themes. When a large hedge, pension, or mutual fund start
accumulating a position, they do so for days, weeks and months. Their
intention is not to buy today and sell tomorrow. They are buying with the
goal to hold for multiple weeks and months. This creates a ripple effect that
skillful swing traders know how to use.
Every year, people become obsessed with a few market themes. There’s
usually a good fundamental basis for it, but financial markets always
overreact to potential opportunities and threats. The Internet in 1996-1999,
defense stocks in 2002-2003, emerging markets (the BRICs) from 2003 to
2007, housing-related names in 2004-2005, solar and basic materials in 20062007, gold and silver from 2010 to 2011, biotech in 2012-2015, etc.
Fundamentals account for the first 20-30% of a move. The rest is usually due
to fear of missing out, greed, self-perpetuating momentum, and short
squeezes. There’s no logic or rational explanation for the magnitude of the
moves.
When to trade this setup
It works well in any market environment.
This is the place to be during range-bound markets when most breakouts and
breakdowns fail and overly active traders get chopped into pieces. Rangebound markets are markets of stocks. There are always some industries that
are trading independently in well-established uptrends or downtrends.
Obviously, we want to be long the strongest stocks in industries that are
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trending up while the general markets are consolidating through time.
In rising markets, industry momentum setups provide better returns and a
higher success rate.
Correlations spike significantly during corrections, but there are still one or
two industries that are leading the way down and offer better risk/reward on
short setups.
When to enter, how much to risk and when to exit
We trade industry momentum setups the same way we trade breakouts and
pullbacks in strong stocks. The only difference here is the way the find those
setups. We use a top-down analysis. We first identify the leading industries
and then zoom in to find the leading stocks and great setups inside them.
We can either buy them on a breakout to new 50-day highs or in anticipation
of a breakout. In a rising market, most industry momentum setups break out
sooner or later. We can buy pullbacks to rising 10 and 20-day EMAs in
stocks with established price and industry momentum.
How to find those setups
Some good sources of industry momentum information are finviz.com,
barchart.com, and IBD.
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Context
The best performing stocks in any given year are usually the ones that
surprise the most. This means that they either:
1. come from an industry no one expects, or
2. report several big earnings surprises in a row.
There are two types of industries people don’t expect to perform well each
year - the ones that were up the most over the past 1-3 years (because no one
believes they can go any higher) and the ones that were down the most in the
past 1-3 years (because people have long written them off).
Industry momentum could be short-term - based on sector rotation or longterm - based on a secular change.
Focus on the industry that is currently on fire, be it on the long or the short
side. Not all setups are created equal. You have found a stock with range
contraction. Big deal! Does it belong to a currently hot industry? It makes a
huge difference. A great technical setup in a currently hot industry could
deliver a 20-30%, even 50% move in a week or two. The same technical
setup in a not so hot industry could deliver 5-6%, maybe 10% gain after it
triggers, if we are lucky.
The edge of industry momentum is structural. This means that it doesn’t
matter how many people use it, it’ll continue to work. It’s an inherent part of
the way markets work. There’s constant sector rotation. That rotation doesn’t
last one or two days. Once under way, it lasts for weeks and sometimes
multiple months, providing multiple excellent risk/reward opportunities in
many different names.
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Examples
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Chapter 5
EARNINGS GAP SETUPS
How to Profit from Post-Earnings-Announcement Drift
There are four earnings seasons each year. Every earnings season provides
new information that could significantly alter market’s expectations about a
stock. Prices change when expectations and perceptions change.
Earnings season is a time of volatility and incredible opportunities. Earnings
reports have the potential to start a major new trend or to end a multi-month
advance.
The so-called earnings gap setup is also known as P.E.A.D. or Post-EarningsAnnouncement Drift. It basically states that stocks that gap up on a better
than expected earnings report, tend to drift higher for several days to several
weeks; stocks that gap down, tend to drift lower.
It works well for position trades (3 to 24 weeks), swing trades (3 to 10 days),
and intra-day trades (on the first and the second day after an earnings
release). It is a great source of both long and short ideas.
The setup
Recent earnings announcement: today before the market opened or yesterday
after the market closed.
On the long side, we look for:
Up more than 5% on more than three times its 50-day average daily traded
volume.
Trading above its 50-day price moving average.
Price > $5.
Average daily traded volume > 100k shares.
On the short side, we look for:
Down more than 5% on more than three times its 50-day average daily traded
volume.
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Trading below its 50-day moving average.
Shortable and optionable.
Average daily volume > 100k shares
Price > $10
How it works
Why do stocks continue to drift in the direction of the initial market reaction?
There are several plausible reasons:
1. People tend to initially underreact to new information. At some
point they realize that they might be missing on a big move, so
they panic and overreact. Such behavior could fuel momentum for
quite some time and lead to higher prices.
2. Institutions need several days to several weeks to build a new
position or to distribute an existing one.
3. Short sellers are forced to cover at higher and higher prices, adding
fuel to the fire.
The logic is similar on the short side when a stock gaps down due to worse
than expected earnings. Stocks that miss estimates tend to continue lower
for several days to several weeks or more in some cases. If you have to
balance your portfolio with some short positions, negative reactions to
earnings reports are among the most reliable ideas you can find.
The most important ingredient in this setup is the market reaction to earnings.
It doesn’t matter what the number is, but how the market actually reacts to it.
Remember that markets are forward-looking, most of the time. If everyone
expects a company to report a strong quarter, this is most likely already
reflected in its price. We see a big market reaction when there’s a genuine
surprise.
Positive earnings surprises work because people panic either due to fear of
missing out on the next big winner, or due to fear of losing (if they are short).
Negative earnings surprises work because the fear of losing escalates with
each tick lower when you are long a name that is breaking down.
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When to trade this setup
It works best during rising markets and right after a major market correction.
It works fantastic right after a major market correction because expectations
are very low.
Big surprise (it means that expectations were very low) + big growth
acceleration = big moves.
In a bull market, this combination will lead to a big one-day move and then
an immediate continuation. The stock can rally for multiple weeks.
In a range-bound or declining market, this combination will lead to an upside
gap and then sideways consolidation. In some cases, there will be another leg
higher, which is a sweet spot for swing traders.
Most upside earnings gaps fail during market corrections.
Earnings gap setups don’t work flawlessly every quarter. As any good setup,
it goes through periods of not delivering good results. This discourages
people from using it and just when most have forgotten about it, it magically
starts to work again.
When to open a position
1. Intraday right after the earnings report is released. For long setups,
look for a small base above a stock’s vwap (volume weighted
moving average) and buy the intraday breakout. The same logic
applies for short setups - look for small bases below a declining
vwap and short the breakdowns.
2. On the second day after an earnings report is released - buy the
breakout above the first day’s highs.
3. Wait for a sideways consolidation above a rising 10- or 20-day
EMA and buy the breakout above that consolidation.
The entry techniques that I shared in chapter 2 of this book can be applied on
this setup as well.
Where to put your stop
For long swing ideas, stops are half a percent below the lows of the entry day
or right below a stock’s 10-day EMA.
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For short swing ideas, stops are half above a stock’s 10-day EMA. Short
ideas typically need more wiggle room to work out.
Position sizing - how much to risk and how many shares to buy
Risk 1% of capital during market uptrends - when all major market stock
indexes (IWM, SPY, QQQ, and MDY) are trading above their 50-day
moving averages.
Risk 0.5% of capital during range-bound markets (when some of the major
indexes are below their 50-day MA and some are above).
Risk 0.5% of capital on short setups.
Exit strategy
If you don’t know why you got in, you won’t know when to exit. Your exit
strategy depends on your trading horizon. Are you an intraday trader, swing
trader or a position trader? Swing trades usually last between 2 and 10 trading
days. Position trades last between 2 and 24 weeks in most cases.
For swing trades, sell half 3 to 5 days after your entry. Sell the rest on a close
below a stock’s 10-day exponential moving average.
For position trades, sell half after three up weeks in a row. Sell the rest on a
close below a stock’s 50-day simple moving average.
How to find those setups
There are several websites that provide reliable information on earnings
estimates and surprises - earningswhispers.com and estimize.com are two
good examples. The market reaction to earnings is far more important than
the actual number for this setup. You can easily track that on finviz, which
allows you to screen based on earnings dates.
You can create a watch list of highly positive and negative reactions to
earnings surprises and use it as a source for swing trade ideas.
Context
Earnings reports often play the role of pivots in stocks. Sometimes an
earnings gap could be the beginning of a powerful price trend that can
continue for several quarters. Other times, an earnings gap could lead to an
end of long-term trends.
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As a rule of thumb, market reaction to earnings is what matters, not the
reported number. If you see a momentum stock (or any stock) declining after
reporting significant growth above analysts’ estimates, this is your clue that
its trend is probably over. Such reaction typically happens in weak markets.
If, on the other side, a company reports terrible numbers and its stock rallies
– this is usually super bullish and also an indication that we are in a strong
market that is able to brush all bad news aside.
The most powerful uptrends start when there is an alignment of:
A) Positive market reaction. You can tell a lot about the current state of
market sentiment based on how markets react to earnings surprises. Bottoms
are often made when stocks stop going down on bad news. Tops are often
made when stocks stop going up on good news. In both cases, the worst and
the best case scenarios have already been discounted by the market. Markets
tend to overreact to known risk and underreact to genuine surprises.
B) Powerful earnings and sales acceleration - for example a company that
used to grow at 0% to 15%, suddenly reports a 100% increase in earnings and
50% increase in sales. This is a notable change that can attract many new
buyers.
C) Genuine earnings surprise in a relatively neglected stock - preferably
one that has moved in a range for a long period of time. People first
underreact to genuine surprises, then realize they are wrong and overreact.
They go from neglect to acknowledgment (fear of losing) to complacency
(fear of missing out).
The impact of an earnings surprise can be significantly magnified by a small
float, small market cap and high short interest.
Earnings gap setups can also be excellent longer-term position trade ideas
because of the so-called cockroach effect in earnings trends. The first major
earnings surprise is usually followed by several more earnings surprises.
Each new earning surprise fuels the established trend. After a few earnings
surprises in a row, market expectations catch up and the established trend
slows down or even reverses.
Big earnings surprises bring a lot of liquidity with them as more funds are
getting involved. This means that you could apply this setup even on big
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multi-million-dollar trading accounts.
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Examples
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Chapter 6
SHORT SQUEEZE SETUPS
How High Short Interest Might Lead to Explosive Short-term Moves
People can bet against stocks by shorting them (borrowing and selling them
on the open market without owning them). Their goal is to buy them back
later at much lower prices. Their reasons vary - extremely high valuations,
expectations of an approaching market correction, worse than expected
earnings numbers or a good risk/reward technical setup. Sometimes, short
sellers are wrong or early (another word for being wrong) and they are forced
to cover their short sales at higher prices and lose money.
A short squeeze is a rapid increase in a price of a stock caused when short
sellers scramble to cover their positions.
In early 2013, 31 million of Tesla Motors (TSLA) shares were sold short. At
the time, Tesla’s float was about 100 million shares. Basically, one-third of
its shares were sold short. In April 2013, TSLA broke out to new all-time
highs. In the following year, it went from $43 to $260, as short sellers were
forced to cover their bets at higher and higher prices.
Tesla is an extreme short squeeze example. Similar, but smaller in magnitude
short squeezes happen every single year. This chapter teaches you how to
recognize them and trade them.
The setup
The specific characteristics of this setup depend on the type of market
environment - confirmed uptrend or right after a major market correction. For
now, all you need to know is that we look for liquid stocks with very high
short float. I’ll provide more details in the market timing section.
Very high short float. Usually bigger than 20%.
Price > $5
Average daily traded volume > 100k
The short squeeze effect can be magnified by the float and market
cap of a stock. It works better with small-float (under 50mm
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shares) and small-cap stocks (under 2 billion).
Stocks with a high short float are typical targets for short squeezes.
Float is the number of shares available to trade on the open market.
Short Float = Number of shorted shares / Float
Float = Outstanding Shares - Restricted shares.
Outstanding shares are decided by the board of directors of each company.
Outstanding shares * Current stock price = Current market capitalization.
Restricted shares are owned by insiders - management, employees, founders,
venture funds, etc. For example, employees and management often receive
stocks and options as a form of compensation, and they are not able to sell
them until a certain time passes.
How it works
Traders look for catalysts because catalysts can move prices. Having a high
short interest is a potential catalyst. It means that many people have bet
against a stock by selling it short. They all hope to cover at lower prices and
make a tidy profit, but this doesn’t always happen. Sometimes, they are too
early. Sometimes, they are simply wrong for other reasons.
Finding a great short trade is a two-step process: stock picking and market
timing. The second step is a lot more challenging. In the trading world, there
is no difference between being too early and being wrong.
When you are short a stock, you will have to cover at some point. Covering
means buying. When a large number of short sellers buy, the price of a stock
can go up a lot, and fast. Short sellers cover for two main reasons:
A.
When the stock they are shorting has been absolutely decimated
and reached their target. This often coincides with the lows of market
corrections.
B.
When they are forced to cover, because the price of the stock
they are short, keeps going higher and higher.
When to trade this setup
Short squeezes work best either during a confirmed market uptrend or right
after a market correction.
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We have a confirmed market uptrend when all major stock indexes - small
caps (IWM), mid caps (MDY, and large caps (SPY, QQQ), are trading above
their 50-day moving averages and their 10-day exponential moving averages.
A market correction is considered any bigger than 10% pullback in the S & P
500. We never buy blindly after 10% pullbacks. We look for some signs of a
bottoming process like breadth and momentum divergences.
The most powerful short-squeezes tend to happen at the beginning and at the
end of a major market uptrend because short-sellers don’t believe that a shortsqueeze could happen at those levels.
At a beginning of a new major trend, they are too complacent due to a recent
period of making a lot of money on the short side or watching other people
make money on the short side. They underreact to new developments in
supply/demand dynamics, which is a great recipe for a short-squeeze down
the road.
At the end of a major uptrend, many of the most heavily shorted stocks have
gone up a lot, and most short sellers don’t think that they could go any
higher. Guess what? In financial markets, the obvious rarely happens, the
unexpected constantly occurs. What seems high can go a lot higher.
When to enter, how much to risk, and when to exit
There are two major types of short squeeze setups:
1. Near 52-week highs when all short sellers are in a losing position.
2. Near 52-week lows after a major market correction, when short
sellers are locking in profits and the market is starting to recover.
When to open a position
Prices are moved by catalysts. One of the most powerful catalysts in the
market is a combination of high short interest and new 52-week high. The
goal of every short seller is to cover voluntarily at much lower prices. In
many cases, short sellers are either early or wrong and they are forced to
cover at a lot higher prices, fueling price uptrends.
In a rising market, look for high short interest names with established price
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momentum that are breaking out to new 52-week highs. It is not uncommon
to see a stock that has gone up more than 100% in the past year to double
again because of a short squeeze.
The entry point is a breakout to new 52-week highs., A short squeeze has a
better chance of following through if there’s news behind the breakout, like
an earnings announcement or FDA approval.
Tops are a lot harder to recognize than bottoms because stocks tend to top
individually and bottom as a group.
Right after a major market correction, look for high short interest names that
are down more than 60-70% in the previous year and are showing signs of
returning demand. Enter on a bigger than 4% daily move to new 20-day
highs.
Where to place your stop
For swing trades, the initial stop is 0.5% below the lows of the entry day or
right below the stock’s 10-day EMA.
Position sizing - how much to risk and how many shares to buy
I risk between 0.5% and 1% of my capital on this setup.
Exit strategy
For swing trades, take half off 3 to 10 days after your entry. Sell the other
half on a close below a stock’s rising 10-day EMA.
For position trades, you could gradually sell small chunks on the way up or
wait for a close below a rising 10-week moving average. For example, sell
one-half to a full position after three up weeks in a row, especially if the
range on the third week is several times bigger than the range in the previous
two.
How to find those setups
Quite a few sources offer the ability to search for stocks with high short
interest: finviz.com, chartmill.com, sparkfin.com, nasdaq.com,
shortsqueeze.com, highshortinterest.com, etc.
Context
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When a stock has a very large short interest, we know that:
A) Someone has done extensive homework and probably found out either
accounting discrepancies, major structural business challenges or a big
difference between current market valuation and actual worth of the business.
Short sellers are often right in a long-term perspective, but they could be
very, very wrong in a short-term perspective and get squeezed higher.
B) High short interest today means potential for high demand tomorrow –
short sellers could be forced to cover at higher prices when a position goes
against them, or they might cover on their own when a stock declines to their
target levels. In both cases, their covering will be a solid source of demand at
some point.
High short interest doesn’t guarantee that a stock will squeeze higher. It is
just potential energy. When combined with momentum, it could lead to
higher prices.
Keep in mind that usually short sellers do their research and they are often
right in a long-term perspective. The squeezes work because short sellers’
timing is often terrible.
In most cases, short squeezes are tactical, short-term swing trades. Don’t hold
them over events that can cause a big gap like FDA approvals or earnings
reports.
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Examples
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Chapter 7
HUGE VOLUME SETUPS
How to Quickly Grow a Small Account
People keep saying that volume is irrelevant nowadays. Price is all that
matters because price is the only thing that pays. This is a valid and strong
argument, but it doesn’t reflect reality. I encourage you to study the bestperforming stocks on a weekly, monthly or quarterly time frame. Let me save
you some time. Once you are done with your research, you will likely realize
that huge-volume range expansions often lead to big and fast price
appreciation. It literally pays to pay attention to stocks that break out on huge
volume. And by huge, I mean ten times their average daily traded volume.
The setup
Daily price gain is over 10%. The stock doesn’t have to close
above its opening print, but it is preferable.
Price is over $1 and under $20 (under $5 is even better)
Volume > 10x the average daily volume (20x is even better)
Small market cap: under $2 billion (under $300mm is even better)
Small float: under 30mm shares (under 10mm shares is even
better)
Breakout from recent range contraction - a stock that has been
neglected for a long time suddenly starts to move. The reason
could be related to major changes in its industry, big earnings
report or FDA approval, if it concerns a biotech name.
The small-cap index, Russell 2000 is in a confirmed uptrend.
How it works
There is a very high positive correlation between volume and price range.
When a stock experiences a ginormous price breakout on ten times its
average daily volume, it shows up on the radar of many intraday and swing
traders. The stock is very likely to remain “in play” for several days to
several weeks (even months in some cases) after its breakout, offering
multiple entry opportunities along the way.
A huge volume breakout means that something major has happened in the
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price cycle of a stock. It might not be related to a change in fundamentals. It
could be due to a change in perceptions.
Monster volume breakouts attract a lot of speculative money and they can
lead to huge and quick moves. We are talking 50% to 1000% in a few weeks.
The reason behind the breakout is not important. Stocks run on sentiment and
momentum in a short-term perspective. Such types of explosive moves often
end up giving back 80% to 100% of their upside moves, but while they last
they could be amazing trading vehicles for both, intraday and swing traders.
Every single year, there are easily more than 10-20 such moves in underfollowed neglected stocks. If you build a proper process for finding such
candidates and learn how to manage those trades, you could very quickly
build a small account into something big enough to consider trading a fulltime profession.
When to trade this setup
Huge-volume breakouts happen in any market environment, but they don’t
always lead to a sustained move higher. The best environment to trade this
setup is when the small-cap index, Russell 2000 (IWM), is in a confirmed
uptrend. This means that IWM is trading above its 10-day EMA, which is
above its 50-day simple moving average, which is above its 200-day simple
moving average. The fear of missing out is a lot bigger than the fear of losing
in those conditions, which makes them a great habitat for wild speculations
and quick moves in low-float and low-priced stocks.
When to open a position
Big volume and price expansions are often the starting point of powerful new
trends, but we should never buy them blindly. Those setups lead to very fast
moves, up and down. Waiting for a range contraction on a smaller time frame
(5-minute candles for intraday trades and 30-minute candles for swing trades)
and then buying a breakout from that consolidation can improve our success
rate and profitability substantially.
The big-volume range expansion could have an immediate continuation and
remain in play for several weeks after a big breakout. It can also be followed
by a 2- to 20-day sideways consolidation or price pullback to a moving
average (10- or 20-day EMAs) before there is another leg higher.
Position sizing - how much to risk and how many shares to buy
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You should never risk more than 1% of your capital on any short-term trade.
Be very diligent. Those type of stocks tend to move very fast, in both
directions.
Where to place your stop
Several cents below the range contraction zone you used as a base to enter.
Exit
We look for big 5 to 1, 10 to 1, even 20 to 1 reward to risk trades. I like to
use a time stop on those setups as well: sell half 3 to 5 trading days after I
entered; sell the rest on a close below a 5- or 10-day EMA.
How to find this setup
Finviz.com and barchart.com are good sources.
Context
These types of setups can be very hard to hold overnight because they tend to
gap significantly above or below the previous day’s closing price. This might
be positive in a raging bull market, but we should not get overly complacent.
You should have reasonable expectations and an exit strategy. Not every
huge volume breakout will lead to a big move. Taking small losses is
absolutely essential when playing those type of setups. You are likely to be
wrong at least 50% of the time on those setups - even during bull markets.
Keeping your losses small is of utmost importance.
What do you do when a setup doesn’t work the way you expect?
1. Take your loss;
2. If a large number of your setups stop working, then the market
environment must have changed. There is probably distribution
going on, and you might start looking for short ideas and hedges.
One of the biggest mistakes aspiring swing traders and momentum investors
make is staying with their losers for too long. Once a stock hits your stop,
please get out. It is ok to be wrong. It is not ok to stay wrong.
Traders protect capital by taking small losses. Investors protect capital by
having a well-diversified portfolio or buying short-term put options on their
large individual stock holdings when market conditions start to deteriorate.
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By far the most frequently asked question I get asked privately via email is
some variation of “I am down 30% on such and such stock and I can’t take it
anymore. Tell me what to do – take a big loss or hold?”.
I understand the precarious state of the situation. I’ve been there several times
in my career. In this case, there’s no point of telling people that they should
always always have an exit strategy.
What I usually tell people is that the loss has already happened. Since it is in
an individual stock, there are no guarantees that it can’t go lower or that it
will ever recover to their break-even point. Now, it is up to them if it will
remain just a loss or become a habit-changing lesson.
There is a difference between a drawdown in an individual stock and a
drawdown in a well-diversified index. The latter is usually actively
rebalanced every year and it tends to recover over time – some do faster than
others.
The questions you need to ask yourself are:
1. How much money are you really comfortable losing on this one position?
It doesn’t make sense to risk more than 1% of your capital per idea.
2. Would you buy at the current levels again? What is your stop if you do?
3. Why do you need to make money exactly in that name? There are
thousands of liquid stocks out there. The odds are that at least several of them
offer better risk/reward entry points at the time and have a better potential of
making you money.
Your first loss is your best loss. Staying with a large loser has a detrimental
impact on your health and well-being. You get obsessed with this one
position and as a result, you miss on so many other good opportunities that
the market generously provides every week.
What would I do in your situation? I’d take a large loss and move on. Then
I’d take a few days to recharge emotionally, review past trades, study former
winners and losers, talk to other traders that have been there.
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Sometimes, being wrong is not a choice. Staying wrong always is.
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Examples
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Chapter 8
BEARISH SETUPS
How to Make Money during C orrections
A correction of at least 8% in a major market index happens every single
year. In some years, it occurs more than once and it is much bigger than 8%.
Market corrections create fantastic opportunities for nimble traders because
stocks tend to fall a lot faster than they climb.
The setup
The general market is in a correction mode - this helps with the overall
success rate of any short positions and the average size of their move.
Price > $15.
Average daily volume > 200k shares.
Price < 10-day EMA < 50-day SMA.
Down >3% from the previous day’s closing price.
Down 2% from today’s open.
The stock is making new 5-day low or finding resistance near its declining
10-, 20-, or 50-day moving averages.
It is not down three days in a row.
It is not down more than 10% in the past three days.
Price being below its 200dma is a big plus, but not necessary.
50-day simple moving average doesn’t have to be below 200dma, but it can
be helpful.
An alternative of going short an ETF is going long its corresponding
leveraged inverse ETF to add some beta to our returns.
How it works
Bear setups work incredibly well during corrections because most stocks go
down during corrections, regardless of individual merits. Fundamentals are
irrelevant in a short-term perspective when fear of losing and forced
liquidations cause massive selloffs.
When funds have to sell, they need multiple days and weeks to distribute
their positions. The liquidity might not be there for them when they need it
the most. This can cause quick moves to the downside and scare people into
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even more selling. Just like optimism can be self-perpetuating during rising
markets, pessimism and fear feed on themselves during steep market
declines.
Bull markets are typically markets of stocks, which provide good
opportunities on both, the long and the short side. Corrective markets are
very high correlation markets.
Are you familiar with the 50/30/20 concept? It states that 50% of a stock's
move is defined by the general market direction; 30% by its industry, and
only 20% is impacted by the individual merits of the underlying company.
During market corrections, the 50/30/20 rule of thumb becomes something
like the 90/10 rule, where 90% of a stock's move is defined by the general
direction of the market and only 10% by the individual characteristics of that
stock.
When to trade this setup
The optimal trading conditions for bearish setups are when at least two of the
four major market indexes are in a downtrend: small caps (IWM), mid caps
(MDY), and large caps (SPY, QQQ). A downtrend means that the current
price is trading below its 10-day exponential moving average (EMA), which
is below a 50-day simple moving average.
The small-cap index usually leads on the way down and it is the first to break
below its 10- and 50-day moving averages.
Financial markets don’t go from being in an uptrend to being in a downtrend
overnight. There’s a choppy, range-bound market between the two. Pay
attention to leading and lagging industries during range-bound markets. The
first industries to break down are the most likely to lead any future correction
in the market averages and provide some excellent short setups.
When to open a short position
The best time to enter a short setup is when the following conditions are met:
The stock is down >3% from the previous day’s closing price.
The stock is down 2% from today’s open.
The stock is making new 5-day low or finding resistance near its declining
10-, 20-, or 50-day moving averages.
The stock is not down 3 days in a row.
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As a general rule of thumb:
In rising markets, it makes sense to buy bigger than 3% bounces from rising
10- and 20-day exponential moving averages in stocks with established
upside momentum. In declining markets, it makes sense to short bigger than
3% reversals from declining 10- and 20-day EMAs in stocks with established
downside momentum.
Where to place your stop
Stop is the high of the entry day or a close above a stock’s 10-day EMA.
Give your short setups more wiggle room. Market corrections can be very
wild. As long as a short setup doesn’t close above its 10-day EMA, it is still
in play. Notice that I said close, not pierce intraday.
Position sizing - how much to risk and how many shares to buy
Risk is 0.5% of capital. This means that on a 100k capital, the risk per short
setup is $500.
Exit strategy
R is the risk per share taken. For example, if we short a stock at $40 and put
our stop at $41, then R = $1.
When it comes to short setups, I advise partial profit taking - cover half of
your position when 2R is achieved. Most profits on the short side don’t last
long and need to be protected because markets tend to be very volatile during
corrections. Some of the fiercest rallies can happen in corrective periods.
With that in mind, I understand the possible frustration of covering too soon.
What is the purpose of even putting on a short position if you are going to
cover so soon part of it? Since we mainly short when the indexes are in a
confirmed downtrend and in a free fall, letting the other half of our position
run makes sense. Cover the rest on a close above a 10-day EMA or when 710R is achieved.
You can also use a time stop of 3- to 10-trading days if a breakdown doesn’t
follow through.
How to find those setups
You can use the above-mentioned setup characteristics to create a real-time
scan in finviz.com or TC2000. Another very practical option is to create a
watch list of ex-momentum hot stocks that have broken below their 50- and
200-day moving averages. Momentum stocks tend to give up 50% to 80% of
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their upside moves. They are among the hardest hit during market
corrections.
Context
I tend to focus on short setups mainly during market corrections and in rangebound markets with declining market breadth. Some short setups work well
in rising markets, too, but their opportunity cost is very steep. In bull markets,
it is a lot easier to make money on the long side. When most major stock
indexes are in a correction, the majority of stocks get hit pretty hard because
correlations and volatility increase substantially during steep market declines.
One alternative to short setups is going long leveraged inverse ETFs. They
provide all the volatility and therefore potential return that high-beta stocks
do, without any of individual stock risks like earnings gaps or acquisitions.
The benefits of leveraged inverse ETFs is that we have to follow only 20
symbols. They are likely to be super volatile and offer good intraday and
swing-trade opportunities during general market declines.
There are usually one or two major sectors that cause and lead every major
correction. They get hit the hardest. They are different every time. If they
have leveraged inverse ETF, I always prefer to trade them. The return that
they can provide can rarely be matched by shorting individual stocks. For
example, the triple leveraged inverse crude oil ETF (symbol DWTI) went up
400% from November 2015 to late January 2016. The same ETF went up
200% between July and August 2015, and 500% from October 2014 to
January 2015. Leveraged ETFs are usually not fit to be long-term positions,
due to the so-called volatility decay. Given enough time, usually several
years, most leveraged ETFs are likely to experience a 90% drawdown. In a
short-term perspective, they can be amazing trading vehicles.
Keep in mind that corrections look easy to trade only in hindsight. Stocks can
move very fast during general market declines. You blink, and you can miss
the right moment to enter a good short setup. Everything seems like chasing
after that. The increased volatility can make intraday trades very profitable
during corrections, but not everyone can or wants to sit in front of their
screen all day. Swing trades are very challenging, even if you trade in the
direction of the general market, which apparently is down during corrections.
There are times to make money. There are times not to lose money. For the
majority of traders, keeping a very large cash position and sitting mostly on
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the sidelines during corrections is the right thing to do. The opportunities that
will appear after a 10% to 20% drop in a major index will be incredible and
they are usually a lot easier to take advantage from. The bigger the
correction, the better the opportunities afterwards.
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Chapter 9
RELATIVE STRENGTH SETUPS
How to Profit from the Moves of Big Players
Have you ever wondered how you can spot future market leaders before they
have had their biggest moves? There is a way. Stocks that go sideways or
break out during widespread market corrections are usually heavily
accumulated by large institutions. They are very likely to be the new market
leaders once a correction is over. In this chapter, I talk about how to
recognize them and how to trade them.
The setup
Relative strength measures how a stock has performed against a market
benchmark (S&P 500, Russell 2000, Nasdaq Composite) over a period of
time. It has many forms. It can be applied to industries and to individual
stocks. It can be used on various time frames.
The stocks that went sideways or rallied while the general market was
correcting, are likely to significantly outperform once the averages recover.
The industry that went up while the market averages were in a choppy range,
is likely to continue to outperform once the indexes break out.
The industry that outperformed during the first few weeks in a genuine
market recovery, is likely to continue to outperform.
There’s relative strength. There’s also relative weakness, and it can provide
very valuable short ideas.
Industries that break down while the market averages are consolidating
through time are likely to underperform by a lot if indexes also end up
turning lower.
One simple relative strength screen is:
1. Look for stocks that have substantially outperformed the market in
the past one, three, or six months. For example, stocks that were up
more than 20% in the past month, more than 30% in the past
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quarter, and more than 50% in the past six months.
2. Minimum price of $5
3. Average daily traded volume > 100k shares
4. In a strong market, you can buy on a breakout to new 50-day highs
or after bigger than 3% bounce from a rising 10- or 20-day EMA.
How it works
Relative strength is one of the most powerful stock picking techniques. It
reveals what big funds do at various stages of the market’s price cycle, which
stocks they accumulate and which stocks they distribute. Accumulation is
professional buying. Distribution is professional selling.
Why do we care what big funds do? We care because they buy and sell in
size. They move markets. They start and end trends. In most cases, when they
buy, they don’t intend to flip it intraday or in a few days. They accumulate a
position for multiple days and weeks, leaving traces, and creating
opportunities for skillful traders.
Correlations are very high during market corrections. Most stocks move
together, up and down, regardless of individual merits. If a stock makes new
52-week highs while the stock indexes are crashing, this should tell you
something. Someone really wants that stock and they are willing to buy it at
52-week highs while most other stocks are down 10%, 20%, 50%. They
usually have a very good reason for accumulating it. This reason is usually
related to expectations of strong sales and earnings in the future. We don’t
need to know their actual reasons. We pay attention to what big funds do
because their actions have long-term implications.
When to trade these setups
Relative strength and weakness are powerful equity selection tools in any
market environment.
In confirmed uptrends, we pay special attention to stocks with the highest
momentum. These are the best-performing stocks for the past three to six
months. Many of them provide multiple fantastic swing trade opportunities.
Those types of setups work only in confirmed market uptrends. Highmomentum stocks get crushed during market corrections.
In range-bound markets, we look for industry relative strength and weakness.
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Which industries are rising, and which industries are declining while the
market averages are consolidating through time in a choppy range? If the
range is resolved higher, the industries that rose during the range are likely to
be the new leaders. If the range is resolved lower, the weak industries are
likely to lead a market correction lower and provide good short entries.
The logic is the same for general market downtrends and early market
recoveries from corrections.
How to manage those setups
Relative strength setups can be applied in all types of markets. In this chapter,
I’ll cover my approach to them during market corrections and bottoming
processes.
When to buy it
Buy a breakout to new 50-day high from a sound market base or a few days
of tight consolidation. The stocks that went sideways during a market
correction, will be the first to break out once the pressure from the market
averages is lifted. Do not hesitate to buy those breakouts. Breakouts in
individual stocks after 10-20% corrections in the S&P 500 is the probably
one of the best entry points for position traders.
Where to put your stop
Put your stop half a percent below the lows of your entry day or at the current
10-day EMA.
How much to risk
We risk 0.5% to 1% of capital per trade idea. 1% risk on a 500k capital is 5k.
The number of shares we can afford to buy in this case will also depend on
where we put our stop. Let’s assume that we want to buy Netflix (NFLX) at
$122 with a stop at $117. We risk $5 per share. We take our total risk per
trade of $5k and divided by the risk per share of $5. This gives us 1,000
shares.
Where to exit
Your exit strategy will depend on your time frame.
The goal of swing traders is to capture hundreds of 5% to 20% short-term
moves in a year. Selling on strength after three to four up days in a row
makes a lot of sense. You can also wait for a close below a 10-day EMA
(exponential moving average).
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The goal of position traders is to capture multi-week 50% to 100% or bigger
moves and to build size in those stocks or ETFs. Catching such moves
usually requires the ability to stomach 10% to 15% pullbacks. Partial profit
taking makes sense here, especially after three up weeks in a row, where the
price range of the third week is three times bigger than the range of the
previous weeks. A close below a 50-day moving average is another exit
route.
How to find those setups
Good sources of momentum lists are finviz.com, barchart.com, IBD
(Investors Business Daily) and their Market Smith screener. Also, the SL50
list of momentum stocks I put up each week on MarketWisdom.com (it is a
paid product).
You can run a screen for stocks that are up more than 30% in the past six
months and are trading above their 50-day moving average and within 10%
of their 52-week highs.
Keep an eye on the 52-week high list during market corrections and in the
first inning of a market recovery. You can find that list almost anywhere,
including Sparkfin.com and Nasdaq.com.
Context
Relative strength can be used in various markets and on multiple time frames.
The context behind the setup matters a lot.
There are two major types of corrections:
1. Normal pullback within a bull market – This is a garden-variety 5-8%
pullback above a rising 200-day moving average. High-growth momentum
stocks with the highest relative strength during the correction are likely to
outperform during a recovery.
Growth stocks are usually high-beta names that get hit pretty hard in times of
market panic. If any of them manage to hold above their 50-day moving
average, build a new base, or even attempt to make a new 52-week high
during the correction, they will likely outperform significantly during any
bounce attempt. Note that I accentuate growth. During corrections is normal
to see low-beta, high-yield groups like utilities and consumer staples to hold
better than the rest of the market, but they are not going to outperform during
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a market recovery.
2. Deeper 15% to 20% correction in a major index – This one is
characterized by periods of massive forced liquidation when people and
institutions sell not because they want to, but because they have to. These
types of corrections often start below a flat or declining 200-day moving
averages of a major index. Some of these corrections turn into bear markets,
which last more than a year. The best performers during a recovery are
usually the ones that were hit the hardest during the correction – the ones that
are down >80% from their 52-week highs, the ones that were essentially
priced for a bankruptcy, but managed to survive. Some of the most beatendown stocks are likely to go up more than 100% in the first one to three
months into a market recovery. After their initial rally, they will set up again
forming small bases near their 50-day or 200-day moving averages. Then,
they’ll break out and keep going higher, delivering market-beating returns.
Some corrections turn into bear markets. They are rare, but they happen. Bull
markets reward risk-taking, but when the bear puts out honey, he is usually
laying a trap. In bear markets, you buy when the fear of losing is very high,
and you sell when the fear of missing out is very high. As usual, easier said
than done.
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Chapter 10
MEAN-REVERSION SETUPS
When Is the Right Time to Go Against a Trend
There are times to ride a trend. Then, there are times to take the contrarian
path and bet against a trend. Many traders say that they never try to catch
tops and bottoms because it cannot be done consistently. Riding an
established trend is considered less psychologically draining and far more
profitable. And yet, when the right circumstances align, taking a countertrend trade can be done with very little risk and for very big reward.
The setup
Long mean-reversion setup (catching bottoms):
1. Look for stocks making new 52-week lows, but finish near the
high of their daily range, preferably finished green for the day.
2. There should be a positive momentum divergence - price low is
not confirmed by momentum low. Momentum typically leads price
and it bottoms and tops before price.
3. You could buy near the end of the day. Your stop the low of the
day. Target is the declining 50-day simple moving average.
4. These types of setups could deliver quick 20-100% gains after a
major market correction is over.
Short mean reversion setup (catching tops):
1. Big parabolic rally – a stock is up more than 100% in the past year,
and it is trading more than 70% above its 200dma. When a
momentum name breaks down, it will provide numerous shorting
opportunities as momentum stocks tend to give up 50% to 80% of
their upside moves.
2. There is negative momentum divergence - new price highs are not
confirmed by momentum readings.
3. Weak candle - big one-day selloff or a big gap that reverses hard
and closes near the lows of the day. Such type of price action
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reminds people what it is like to lose money and it wakes them up.
Fear of missing out dissipates. Some like to play this for a quick
20% pullback to a 20 or 50dma. Very risky approach that should
only be attempted by experienced traders.
Momentum divergences can be measured via RSI (relative strength index). It
is a momentum indicator that measures the speed and change of price
movement in a security. It is offered for free by almost all charting platforms.
Momentum is often a leading indicator. It tops and bottoms before price does.
When we see a stock making new 52-week high that is not confirmed by
momentum, we say that there is a negative momentum divergence. Negative
divergences can lead to a change of trend. Usually from an uptrend to a
sideways move or downtrend.
When we see a stock making new 52-week low that is not confirmed by its
momentum indicator (RSI), we say that there is a positive momentum
divergence. Positive momentum divergence can lead to a trend reversal from a downtrend to sideways or uptrend. Negative momentum divergences
work better when they happen simultaneously to multiple stocks and ETFs.
This happens because stocks tend to top individually, but bottom as a group.
How it works
Both long and short mean-reversion setups are based on the principle that
from failed moves come fast moves.
When a stock stops going down on what appears to be bad news, the bottom
is usually very close.
False breakdowns in beaten-down stocks trap new shorts and shake down the
last convicted bulls. When short sellers are forced to cover, they could start a
major rally.
The same logic applies on the short side.
When to trade this setup
Contrarian setups don’t work well in trending markets. A trending market is
one where all major market averages (symbols IWM, SPY, QQQ, MDY) are
trading above their 50-day moving averages. Don’t fight trending markets.
You will lose money.
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Mean-reversions work best in range-bound markets and near market bottoms.
During range-bound markets, the major stock indexes trade all over the place.
A typical range-bound market is one where small caps (IWM) and mid-caps
(MDY) trade below their 50-day moving average while at least one of the
large caps ETFs (SPY or QQQ) is trading above its 50-day moving average.
We often see high momentum stocks (the ones that went up over 100% in the
past year) start to break down during range-bound markets. In fact, this is one
of the signs that a range won’t be resolved higher, but most likely lead to a
market correction.
Bottoming processes are essentially range-bound markets with a lot more
volatility and bigger daily price ranges. Bottoms are formed by panic selling
caused by forced liquidation. A forced liquidation happens when people and
institutions sell their stocks, not because they want to, but because they have
to. Near the end of a panic selling, smart short sellers cover their short
positions and experienced long-term holders start buying aggressively. This
leads to a pivot point and a major reversal, which is often the start of a
sustainable rally.
Two types of stocks are the best performers after a major market correction the ones that held the best and the ones that were hit the worst during the
correction. The ones that were hit the worst offer incredible mean-reversion
trades in the initial stages of a market recovery.
How to manage these setups
For short mean-reversion setups:
Look for negative momentum divergence. Go short on the day of a fake
breakout and a major downside reversal. Your stop is the high of that same
day. Price targets are the 20- or 50-day moving averages.
For long mean-reversion setups:
Look for positive momentum divergences in multiple stocks and ETFs. Go
long on the day of a fake breakdown and a major upside reversal. Your stop
is the low of the same day. Price targets are the 50- or 200-day moving
averages.
You can see some examples at the end of this chapter.
Remember, mean-reversions only work during range-bound markets. Tesla
(TSLA) showed negative momentum divergence all the way from $120 to
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$300. Valeant Pharmaceuticals (VRX) showed positive momentum
divergence all the way from $70 to $20. The market environment is the major
ingredient of mean-reversion setups.
Position sizing
Risk between 0.5% and 1% of your capital on those. A smaller risk makes
more sense because of the high volatility near major turning points.
How to find these setups
Pay attention to the 52-week high and low lists on finviz.com or
barchart.com, and look for fake breakouts and breakdowns, major reversals,
and momentum divergences. Checking for failed breakouts and breakdowns
takes about 10 minutes a day, if you structure your screens properly. It
provides setups that very few people are going after.
You should only look for mean-reversion setups during range-bound markets.
Context
Trading is hard because many people try to catch tops and bottoms in quickly
moving stocks. Contrarians are usually wrong.
The right circumstances for a good mean-reversion trade align very rarely.
Momentum divergences don’t always lead to a trend reversal; sometimes,
they just lead to a consolidation through time.
Volatility spikes substantially near pivot points. The daily and weekly price
ranges near tops and bottoms are insane. Taking a contrarian position is often
very challenging because you can be easily stopped out before a stock
reverses in your favor.
Mean reversions should be traded mainly by very experienced traders
because they are hard to pull off. For each example of a mean-reversion trade
that worked great, there are five that didn’t work.
The best thing that could happen to an experienced trader is a 20%+ market
correction. The absolute best time to buy stocks is after a deep market
correction. The good news is you don’t have to catch the absolute bottom.
You can wait two to three weeks for a bottom to form before you start
allocating money on the long side, and you could still make a lot of money.
Also, you don’t need to catch the exact top in a high-momentum stock in
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order to make a lot of money on the short side. You can wait for it to break
down below its 50-day or 200-day moving averages and find a good
risk/reward short setup there.
If you consider yourself ready to take mean-reversion setups, keep in mind
that recognizing tops is a lot harder than recognizing bottoms because stocks
tend to top individually and bottom as a group.
Stocks that make new 52-week lows in a bull market are usually there for a
good reason. From my perspective, there’s only one market environment
where it is relatively safe to try bottom fishing and the potential reward far
outweighs the risk taken. It is during market corrections when the general
market tests its momentum lows with some form of breadth divergence. In
my book ‘CRASH - How to protect and grow capital during corrections’, I
describe the five stages that a typical market correction goes through:
1. The Guillotine Stage – fast sharp decline that lasts one to three
weeks and leads to a 5-10% loss in major indexes and extremely
oversold market breadth readings. Volatility spikes through the
roof during this stage and it stays there. Indexes close below their
200-day moving average.
2. Short-term bounce that gains back 30-50% of the sharp decline in
stage one. Such bounces often find resistance and reverse lower at
declining 10-, 20-, 50- or 200-day moving averages.
3. Choppy market environment, that gradually whipsaws both bulls
and bears as market often changes directions and daily price ranges
are extremely wide. During this stage, fear is gradually replaced by
apathy and lack of interest in the market.
4. A retest of the momentum low achieved in stage 1. There is
usually some type of breadth divergence – indexes are piercing
below their momentum lows but with improved internals – there’s
a smaller percentage of stocks making new 20-day lows than in
stage 1. If indexes cannot sustain bounce after this retest, we are
probably in the midst of a bear market or a lot longer correction, at
least.
5. Recovery – correlations are very high at this stage. Indexes quickly
reach overbought levels and stay there for a long time. Those who
wait for a pullback, miss the boat.
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Most stocks tend to top individually, but they bottom together as a group.
Fishing for beaten down stocks that are down 80% or even 90% from their
52-week highs only makes sense in stage four of a typical market correction.
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Examples
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Summary
Different setups work in different markets. Everyone makes money in a bull
market. Not everyone keeps it when the market goes into correction or a
range-bound, choppy mode.
There are four major types of markets, and each of them requires a different
approach: Uptrend, Range-bound, Downtrend, and Bottoming Process.
Uptrend: all four major market averages (SPY, IWM, MDY, and QQQ) are
trading above their 50-day simple moving average. Russell 2000, which
represents small caps (IWM) is trading above its 10-day EMA. All long
setups work well in this environment. The ones that provide the best returns
are breakouts in high-momentum stocks and recent IPOs. This is the time to
be extra aggressive in the market and to build up our returns. My risk per
trade in this market is 1% of capital.
Range-bound: the four major market averages (SPY, IWM, MDY, and
QQQ) are trading all over the place. For example, QQQ might trade above its
50-day SMA. SPY is above its 10-day EMA but below its 50dSMA. IWM is
below its 10-day EMA, which is below its 50dSMA. The first thing to do in
this type is to raise our cash levels and cut our usual position size in half –
usually from 1% risk per trade to 0.25% to 0.5%. Then, focus on setups in
industries that show notable relative strength or weakness. Also, postearnings-announcement drift setups.
Downtrend: all four major market averages (SPY, IWM, MDY, and QQQ)
are trading below their 10-day EMA and below their 50-day MA.
Correlations and volatility are very high in this type of market. My strategy is
to be in at least 50% cash and long volatility and inverse leveraged ETFs with
the rest. Due to the increased volatility and wild daily ranges, I might dabble
in some intraday trades as well. Risk per trade is 0.5% of capital.
Bottoming process: I wrote a whole book on the subject of market
corrections (‘CRASH – how to protect and grow capital during corrections’).
Basically, bottoms are recognized when there are momentum and breadth
divergences in the four major market averages: SPY, IWM, MDY, and QQQ.
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My setups of choice in this market environment are: 1) Mean-reversions in
the most beaten-down and the most shorted stocks - these have the potential
to deliver 30% to 300% gains one to six months after a market bottom is
established. 2) Leveraged long ETFs - correlations are very high during the
first leg of a recovery; therefore, ETFs like TQQQ (3X Nasdaq 100) and
others can be a lazy and very efficient way to participate in a market
recovery. The best time to establish new multi-month position trades is after a
market correction. 3) Relative strength setups - the stocks that consolidated
through time while all market averages were in a correction mode, are likely
to significantly outperform once the market starts to recover. Risk per trade is
1% of capital.
Setups that work flawlessly and deliver incredible returns during market
uptrends, don’t have an edge in range-bound or corrective markets. No edge
means that you are gambling.
Many people can achieve very good results by focusing on trading only
during confirmed market uptrends and staying in cash the rest of the time.
The stock market meets my definition of an uptrend about three to four
months in any given year.
If your goal is to extract money from every market environment, then you
need to be flexible and willing to adapt to changing conditions. Different
setups work in different markets. Have a specific setup for each market.
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About the Author
Ivaylo Ivanov (@ivanhoff) is a full-time trader.
Ivaylo is a founder of MarketWisdom.com, where
he offers mentorship and market education on swing trading and momentum
investing.
Mr. Ivanov is the author of:
Top 10 Trading Setups – How to find them, how to manage them, how to
make money with them.
CRASH – How to Protect and Grow Capital during Corrections, which is a
solid game plan for every market correction.
The Next Apple – How to Own the Best Performing Stocks In Any Given
Year, which explains the reasons behind big long-term market moves and
outlines ways to find and ride big stock market winners.
The 5 Secrets To Highly Profitable Swing Trading, which is a great
introduction to swing trading, very simple and straight to the point, no
unnecessary fluff, just actionable information.
The StockTwits Edge - 40 Setups from Real Market Pros, which features the
story and the market approach of 40 seasoned pros with wide following in
social media.
Ivaylo’s work has been featured on Bloomberg, WSJ, Yahoo Finance,
Reuters, CNN Money, UT San Diego, Traders Magazine, Abnormal Returns,
Real Clear Markets, The Reformed Broker, Zero Hedge, etc.
Follow me on Twitter and StockTwits: @ivanhoff
ivanhoff.com marketwisdom.com
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Other Books by the Author
Crash – How to Protect and Grown Capital during Corrections
Crash Course on Market Corrections and the
Ensuing Recoveries
The odds of an investor experiencing a big market
crash during his/her life are 100%.
A well-diversified portfolio will save you from losing
money in any 10-year period, but it also “save” you
from achieving high returns over time. Diversification
won’t save you from experiencing big drawdowns during market panics
when correlations go to 1.00 and all assets move together up and down
disregarding of underlying fundamentals.
Paul Tudor Jones says that “once in a hundred years events” have started to
occur every five years. Obviously, his comment is more of an anecdote than a
statistical fact, but it is also a reflection of a timeless market truth – the
obvious rarely happens, the unexpected constantly occurs.
The stock market is not a place, where for one party to win, another has to
lose. It is a place, driven by cycles – periods when almost everyone is a
winner followed by periods when almost everyone is a loser.
Everyone could make a lot of money during market rallies when liquidity and
performance chasing lift all boats and trump all bad news. Not everyone
keeps that money when the inevitable correction comes.
By reading this guideline, you will become better educated in the following
subjects:
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How to protect capital during market corrections
When to raise cash, take profits and sell long holdings
When and how to hedge
How to remain calm and protect your confidence during corrections
How to make money on the short side during market corrections
How to survive extremely choppy periods during market corrections
How to be flexible and prosper during long bear markets
How to recognize market bottoms
How to make money during market recoveries
How to use social media during corrections
THE NEXT APPLE
If your goal is to achieve average market returns, just
consistently put money into low-cost indexes and get it
over with. If you are going to spend time, effort and
money on learning how to invest, make sure it’s worth
it. The only reason to actively pick stocks is to achieve
returns that will make a real dent in your universe.
When you are done with this book, you will know
everything you need to know in order to find and profit from the next Apple,
Starbucks and Tesla of the world. You will be a smarter and more
knowledgeable investor.
Here is a brief sample of questions we answer in the book:
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• Can you find the next Apple, Google or Tesla?
• Do what you love and success will follow is the most frequently given
advice. Is “Invest in what you love/know” an equally bright idea?
• Does past performance impact future returns? The answer might surprise
you.
• How to find the best performing stocks in any given year? It’s a little
counter-intuitive, but if you do what everyone else does, you cannot expect to
achieve superior results.
• George Soros says that sometimes the market could predict its own future.
Is the market always correct, and more importantly, how does that affect you
as an investor?
• Timing is everything in investing. When is the absolute best time to buy,
and which stocks should you buy?
• Some trends last only several quarters before they fade while others
continue for years and deliver fantastic returns. Sooner or later, every trend
ends. This is not an opinion. It is a fact. How do you make sure you keep
your profits when a trend inevitably ends?
• Why don’t you need to know the future in order to consistently make
money in the stock market?
The only question that will remain is whether you will put that knowledge to
work and create a better life for you and your closest people.
The 5 Secrets to Highly Profitable Swing Trading
Why So Many Pros Swing Trade
There are two major ways to consistently make money in the market:
1) Hunt for several huge winners in a year. Build large positions in them and
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ride them for monstrous gains.
2) Hunt for hundreds of 5% to 30% short-term
winners, where the goal is to compound capital
quickly by actively moving in and out of them.
There is not right or wrong approach here. Both have
place in the arsenal of each active market participant.
Everything comes at a price. If you want to catch a 200% to 300% long-term
winner, you have to be willing to sit through multiple consolidations and
several bigger than 30% pullbacks. Not everyone has the stomach to ride big
stock market gainers, but maybe you don’t have to.
If you sell all your winners, when they are up 20%, you will never catch a
double or a triple. Fact.
What is also true is that in any given year, there are a lot more 20% moves
than 100% moves. If you learn how to catch hundreds of quick 5% to 20%
moves, your capital could appreciate very quickly while you keep you keep
the drawdown in your account to a minimum.
Swing trading is among the fastest way to grow capital if you learn how to
properly apply its principles. Swing trading is all about velocity and
opportunity cost of capital. The goal is to stay in stocks that are moving
quickly in our favor and avoid “dead money” periods.
Stocks move in 5% to 30% momentum bursts that last between 2 and 10
days, before they mean-revert or go into sideways consolidation. The goal of
every swing trader is to capture a portion of a short-term momentum burst,
while avoiding consolidation periods. Then to repeat the same process
hundreds of times in the year by risking between 0.5% and 1% of capital per
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idea.
The beauty of swing trading is that it provides many signals. You don’t need
to risk a lot per signal. You won’t second-guess yourself whether to take a
signal or not. One trade is not going to make your year or your month, but it
also won’t ruin it. It relies on the magic of compounding. The idea is to grow
capital quickly by being leveraged to the hill during favorable periods and
being mostly in cash during unfavorable periods.
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Disclaimer
The views expressed in this book are the personal views of the author only
and do not necessarily reflect the views of the author’s employer. The views
expressed reflect the current views of author as of the date hereof and the
author does not undertake to advise you of any changes in the views
expressed herein. In addition, the views expressed do not necessarily reflect
the opinions of any investment professional at the author’s employer, and
may not be reflected in the strategies and products that his employer offers.
The author’s employer may have positions (long or short) or engage in
securities transactions that are not consistent with the information and views
expressed in this presentation. The author assumes no duty to, nor undertakes
to update forward looking statements. No representation or warranty, express
or implied, is made or given by or on behalf of the author, the author’s
employer or any other person as to the accuracy and completeness or fairness
of the information contained in this presentation and no responsibility or
liability is accepted for any such information. By accepting this book, the
recipient acknowledges its understanding.
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Copyright © 2016 by Ivaylo Ivanov
All rights reserved.
Limit of Liability/ Disclaimer of Warranty: While the publisher and the
author have used their best efforts in preparing this book, they make no
representations or warranties with respect to the accuracy or completeness of
the contents of this book and specially disclaim any implied warranties of
merchantability or fitness for a particular purpose. No warranty may be
created or extended by sales representatives or written sales materials. The
advice and strategies contained herein may not be suitable for your situation.
You should consult with a professional where appropriate. Neither the
publisher nor author shall be liable for any loss of profit or any other
commercial damages, including but not limited to special, incidental,
consequential, or other damages. No part of this publication may be
reproduced, stored in a retrieval system, or transmitted in any form or by any
means, electronic, mechanical, photocopying, recording, scanning, or
otherwise, except as permitted under Section 107 or 108 of the 1976 United
States Copyright Act, without either the prior written permission of the
Publisher, or authorization through payment of the appropriate per copy fee.
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