The Anatomy of a Trade

Here’s a trade I put on the other day. I thought it might be useful for you to see someone else’s thought process.

First, the best herds were identified by using relative strength to the S&P. I used an analysis of the sector ETFs that most closely resemble the sectors as defined by TD Ameritrade. The relative strength of Coals and Retail were among the best. On the retail end, BKE was one of the stocks with the best performance during a sector pullback. It was therefore selected as having best relative strength. It should be understood that looking at these stocks for performance involves looking over the last 4 weeks. IMHO, looking at last January has little to do with the here and now, so I don’t care what these candidates have done Year-to-date. It’s kind of like a salary review: “Yeah, but what did you do for me yesterday?”.

We want to enter the trade, but we must realize buying BKE is a very high risk trade. Why? The daily chart stochastics are oversold, and the daily chart looks like it is starting to roll over. Therefore the daily trend is likely lower. Here’s the daily chart:

Chart 1

But we wanted to enter the trade because of the structural reasoning of QE2, and the structural reasoning that we are entering the Christmas season, where retail typically outperforms. (BTW, on the chart, the little spikes below the price action candlesticks indicates the volume. Remember that for the following charts. The name gets covered up by that grey window.)


So we waited until we had a pullback on the 60 minute chart. This pullback resulted in a higher low. We entered at that point. If we did not have a higher low, we would not have entered. We made a buy of 200 shares at 34.05. The stochs are below 20, the momentum and ultimate oscillator have started to rise. See the 60 minute chart, and make sure you understand “higher low” and “pullback”. Why did I choose 200 shares? Look at the “bar point range” on the daily chart, and you will see that in a day, the peak range is about $1, so that means I would lose as much as $200 in a trade that went completely wrong. This is within my risk appetite.

The initial buy of 200 shares happened at 34.05. Actually, this is our third higher low, the first one was on 11/03 at a price of $30. Can you pick out the second higher low?


If we don’t get a higher high, that is above 35, we get out. We watch the stochastics, and when they turn south, we look at the price. If it’s lower than 35, we’re out.

We are approaching the end of the day. What do we do? We look at the volume during the last 15 minutes. If the volume is increasing and the price is increasing we will stay in overnight. If the volume is decreasing or disappearing, or if the price action is falling, we will exit overnight and re-enter tomorrow morning. Volume action is the tell; and in my experience the volume action is often continued after hours. Here’s the last 2 minute chart, look at it and tell me what you see:

Do you see the higher lows on each candle, and the increase in volume from 15:36? That shows commitment to the price action. It is a good indicator that there will be follow through Monday morning. We’ll see.

Well, we saw. This Monday morning, the S&P opened higher, around .39. And BKE is on the rise, the 15 minute relative strength is higher than the S&P, and it’s relative strength curve is positive, meaning it’s getting stronger.

Ok what now? Do we add? No. We look for a cycle of stochastics on the 60 minute chart and add if we see a higher low. See on the 60 minute chart how the stochastics are below the 20% line? When we go up to the 80% line, presumably the stock will have risen in price, and when it returns to the 20% line again, we will look for a price above the 33.90 price, the price we were at at 13:30 which was the inflection point.

Where do we set our stop? At the 33.90 point? No. Looking at the chart, where do you see price support? It’s not at the 33.90 point. There’s no volume commitment there whatsoever. So this is likely a false support point. We do have some volume at the 33.70 point on 11/09 at 13:30. That too is near an inflection point where the stocs started to turn around. So maybe we set our stop at just a little below, at 33.63. Always set your stop at an odd point because it’s interesting how turn-arounds happen at even points, like ¾ of a dollar.

Now our risk is defined. We stand to lose (34.05 – 33.63) * 200 or $84. Plus trading fees.

Suppose we get a higher low, or never get the stochastics to drop below the 20 line. Where do we add?

This depends on your risk appetite and how much money you have. I intend to add at the end of the day if BKE is higher and the market is higher. I intend to wait for the stochs to pull back to the 20% point if the market closes lower but BKE is still higher. So we’ll have to wait and see.

Some traders shift to the 15 minute or 10 minute chart to plot their adds. Then they might add on a higher low on that chart, and adjust their stops. They have greater risk appetites than I.

What’s the next point we look for? If the price goes over 35.07 on this 60 minute chart cycle, we have a higher high, and the 3LB will show no turnaround. That means we’ve had a successful entry on this stock and the 3LB is still showing a positive trend.

Well, here’s the chart:

Chart 4

The stochastics are back up at the top 80%, and we don’t have a higher high. We’re out without adding. Sell Price: 34.58.

On this trade, we made (34.58 – 34.05) * 200 – 22 = $84. So we didn’t lose money, but it looks like the supposition we started with that we are likely to see a correction on BKE is correct: no higher high means to stay in the trade is too risky. Let’s see where we would have been had we stayed in:

Chart 5

Because we never got the higher high above 35, the momentum of the uptrend was broken. We stood to lose money on the trade. Getting out was the right choice.

So when a trade does not do as you expect, get out of it. Any loss should be tiny and what you can afford. If the trade does not obey the rules, get out of it. See the big spike? That means somebody with a big wallet is playing, and they’re using your money while you were in the trade. The way a big spike works with such low volume trades is interesting: somebody can see where market orders are set, and knows how to use this knowledge with small buys at the right price points. Spike, and he's out. Usually, that is the stock operator, and he needs work done on his Ferrari.

If I had stayed in, and saw the spike happen this morning, I guarantee I would be out of that trade. I will never again chase or hold on to a spike. More often than not, you’ll end up a loser. See what happened when the market caught up to this spike? But I’ve got my Burger King money on this one, I’ll go get a double whopper maybe tomorrow.