The Bull Walks up the Stairs and the Bear Jumps out the Window
Learn how to short stocks with our Counter Trend Trading Strategy.
How many times have you seen a strong stock grinding up and you ask yourself why you didn’t get in? Or even worse, you decide to chase it and buy too high. I’ve done it myself more times than I can count. What I realized is that when you miss the breakout spot you have to simply wait for another setup. So when I see a stock grinding up and making new highs I often ask myself where is the top and when can I short this. We often see stocks ramp up, then drop down sharply, ramp up, drop down sharply. I love being in the market for as little time as possible. One of the factors of Risk is our exposure time in the market. When I should a strong stock near the top my stop is always at the high and I look for a quick pull back to the moving averages. This simple strategy works in Bull markets and Bear markets, and allows us to trade both sides of the trend. My counter trend trading strategy provides more opportunities than a single direction strategy.
Reversal Trading Strategy
In addition to trading momentum stocks to the upside, I’m a big fan of trading reversals. One of the first things I realized as a new trader was that it’s impossible to predict when a stock is going to make a big move to the upside or the downside, but almost all of those moves will result in a reversal. Instead of feeling frustrated that I missed a big mover, I see it as an opportunity to trade the back side reversal. The challenge is finding the reversal and not getting in a stock going the wrong direction too early. Since countertrend trading requires guessing the change in trend, it is naturally more difficult that momentum trading. The big advantage of reversal trading is that when you buy a weak stock very close to the bottom, you will have an amazing profit loss ratio. The risk is almost always very low relative to the profit potential. We already learned having a 2:1 profit loss ratio means you can be a profitable trader with just 50% success rate. On reversal trades, I often get 4:1 profit loss ratios. I will have a 10 cent stop at the low of day and get 40-50 cents of profit off the bounce. These types of profit loss ratios mean even if the accuracy rate is lower, you can afford to take more losses since the winners far outweigh the losers.
One of the big questions students will ask is how can I determine if a stock has the potential to make a big bounce. I answer this with an example. Think of a rubber band, when the rubber band gets extremely stretched out, it will snap back with tremendous force. Applying that concept to trading, we need to look for stocks that are extremely extended to the upside or the downside. The biggest mistakes students make is underestimating how extreme the extension needs to be.
Only Trading Extremes
Reversal setups need to be either at high of day or low of day with at least 3-5 consecutive long body candles, although 5-10 is preferable. The final candle in the string of consecutive candles should be a candle outside the bollinger bands. A candle outside the bollinger bands is a definitive indicator of an extreme move. Additionally, I look for the Relative Strength Index to show the stock is either above 80 (overbought) or below 20 (oversold). I require more confirmation to take a reversal since the setup is more difficult to time properly.