Friends, money can be made using the simplest of approaches, relying on basic fundamental and technical analysis. But there are times when more advanced trading strategies create greater confidence and precision in execution.
In a continuing effort to help our followers cultivate a profitable relationship with markets, we have put together this quick primer on a few techniques to help you develop that extra edge.
Included, you will find strategies for dealing with Large Gaps, Extreme Sell-offs, Sympathy Correlations, and Exchange De-listings.
A “gap up” occurs when a stock’s opening price is above the previous day’s closing price. A “gap down” is just the opposite, with the opening price appearing clearly lower than the previous day’s closing price.
The reason this happens is due to pre-market and after-hours trading in that stock or in the general market. Since trading outside of regular market hours is not reflected in the daily stock chart, the visible result is the Gap in the chart.
It’s important to understand that trading outside of regular hours can be extremely risky, and many stocks such as those listed on OTC and Pink Sheets won’t let you do it in the first place.
Hence, we would advise you to avoid this practice altogether. That being said, since stocks can occasionally make extraordinary moves outside of regular trading hours, we find there are often tremendously profitable trading setups defined by reacting to large gaps once the market opens the next day for regular trading.
These opportunities can be divided into Reaction trades and Sympathy trades.
Gap Reaction Trades are trades in the gapping stock in reaction to the gap. Often, when a gap is abnormally large, emotion is to blame. That implies that, many times, the stock’s opening price represents an overreaction to whatever is driving the gap.
Traders can take advantage of this by buying into a gap down after the open, or shorting a large gap higher. But we encourage you to define your risk and use stop-loss orders to prevent getting run over by new revelations that may augment the gapping move.
In Gap Sympathy Trades, the goal is to find stocks that similar to the gapping stock and look to play them off the open as a “catch up” trade. Many times, the market will obviate this opportunity by gapping sympathy plays. But, occasionally, one finds easy money, and we encourage you to keep your eyes peeled.
Extreme Bounce Plays
Emotion dominates the markets as a general rule. We occasionally see huge moves in a matter of hours when this is particularly on display.
When a stock price is diving in a free-fall or death spiral, investors often become overwhelmed and make all decisions from the part of the brain known as the Basal Ganglia, or reptilian brain. This is where such concepts as Fight or Flight, Survival, Eat or Be Eaten and the like are dominant. Decisions are black and white, and only reflect the simplest logic.
So, even the smartest people can end up making really stupid decisions because they are acting with emotional blinders on.
As a result, the end of such moves, known as a ‘capitulation’ often represents a major overreaction that can add as much as 20-40% on to the move.
In addition, when downside momentum and bad news come together, one will almost always see short sellers who circle like hyenas. Their activity compounds the situation and further drives down the price.
However, at a certain point, shorts will have to “cover” (to buy back their share exposure) to monetize their gains. Along with value buyers and shaken-out strong hands, stocks can often see huge snap-back buying following the capitulation of a major downside spiral.
This whole dynamic can give astute traders a huge opportunity.
This strategy can be tense as it is nearly impossible to time things perfectly. However, we suggest a couple strategies to help.
First off, wait for the “Oh My God!!!!” moment to start buying. This just means, don’t worry about buying moderately large declines. And stay away from slowly grinding sell-offs. We suggest waiting for moments where a very large grinding decline turns into an emotional heart-attack spike downward. This assures you that the weak-handed bounce buyers who moved in too early have already been thrown off the bus.
Secondly, use a strategy of scaling in. Once you see the OMG moment, buy a small amount. Then wait. If you get a secondary plunge, buy a bit more and then wait for positive movement. In the end, one should never play such a trade at normal size. Use half size at most.
This should minimize your risk and allow you to take advantage of these dynamic setups.
It is not uncommon to see a stock bounce 50% of its initial fall, sometimes the stock can bounce and recover all of its losses, and even go positive.
When stocks are generally not a scary topic for investors, and the animal spirits are flowing, sympathy trades are often one of the most abundantly successful strategies.
Essentially, sympathy plays are when you buy a stock that is similar, and in the same sector, to a stock that is running higher.
For example, ABC Co announces a new multi-million contract or releases positive earnings. Traders who missed the chance to buy ABC Co will search for a similarly priced stock, in the same industry/sector, to buy in the expectations that the positive news will be reflected in other similar stocks.
A simple scan can help identify stocks that fit that sense of similarity.
One real-life example are rare earth mineral company’s. A couple of years ago, rare earth minerals were all the rage. When a rare earth mining company announced positive news, every stock, even remotely related to the sector, shot higher.
Sympathy plays can apply to most sectors, as well as company’s in bankruptcy (identified with a Q at the end of the ticker).
One of the best recent examples was in the solar power sector, when Solar City really came to life and launched up into the $50 area in just a short time. During that period, SunTech Power (STP), which has become a penny stock, itself saw a massive increase in sympathy with its larger brethren, powering 100% higher in two days.
These plays are a little more speculative, but can provide equally impressive gains.
When a company listed on an exchange, such as the NYSE or NASDAQ, they are required to meet certain obligations such as a minimum share price, or minimum market capitalization.
If they fail to meet this requirement, they have a short period of time to comply to avoid being demoted to a smaller exchange.
In an attempt to get their share price or market cap higher, the company will often issue a series of press releases with positive news on the company.
The news creates excitement and hype, and often substantial buying comes in, causing rapid and dramatic share price increases.
You can profit from these situations by being aware of the companies that are at risk of being de-listed. You can access this information from the relevant stock exchange websites, such as nasdaq.com or nyse.com.
One example that comes to mind in recent history was the early 2012 de-listing avoidance by Supertel Hospitality (SPPR).
The company was at risk of being de-listed late in the year in 2011. But, in an effort to avoid this, they engaged an Argentinean real estate company for an extra attractive deal, receiving about $30 mln in investments and using that to lure in other investors through a mass PR effort.
The strategy worked, pushing the stock above the $1 level, and postponing de-listing.
Knowing the company was in danger of de-listing would have been key for short-term traders, as that was the spur that drove the company to make huge efforts to drive its own share price higher.
There are some basics that fall under the “Keep It Simple Stupid” standard that apply to most any trading situation: trade with the trend, don’t average down on losing positions, quantify your risk and stick to it, etc.
There are also some basic principles to follow on the fundamental side: look for pre-revenue growth markers, avoid overwhelming debt, favor low-float stocks, etc.
But there is also something to be said for having a few more advanced strategies in your playbook for special situations that can really supercharge your returns. We have outlined a few such strategies above and we hope you have found them interesting and educational.