Sometimes you have to break a few eggs to make a good omelet. That's how it is with big gap- down plays. Psychologically, I find it one of the tougher strategies for most people to play, and yes, I include myself in that list. It is a tough strategy for two reasons. Well, at least two key reasons in my view.
First, there are often going to be more losing trades than profitable trades. Don't confuse this with losing money overall, but you're likely to only have 30 or 40% of your trades be profitable if you hold to a tight stop loss strategy. In other words, you are going to have to endure quite a few small losers to get a big winner.
The second issue is taking those losses. When you buy a stock already down 15% or 20% on the day and then it breaks to new lows, most folks will hesitate to stop out. Heck, the stock is already down 15%, so how much more can it drop? Don't ask the question! I can say from experience that you do not want to find out the answer while being long.
I would add a 2a, an addition to the second challenge, and that is averaging down. You may be tempted, but do not do it. Chances are you should be selling if you are thinking of averaging down. But at the very least, it should make you re-examine your stop and the current setup.
This morning Abercrombie and Fitch (ANF) is a good example. It was one of four names I traded, which also included Veeva Systems (VEEV), Trinet Group (TNET) and Bob Evans (BOBE).
ANF opened the day down a little , about $1.50. It then quickly fell almost another $1. Although I didn't have confirmation from the RSI, there was a cross on the slow stochastics making me believe this might have a chance to bounce as a buyer around $21.60. The stock did bounce a small amount, but not to where I was looking to take profits. Then a big red bar closed at the low of the day. It was time to exit without a bounce. A minute later we were under $21.50 and I was out with a loss.
It doesn't matter if it was $0.12 per share or $0.50, the loss was a loss. The normal reaction is to expect a bounce, because that's what we do as traders. We say, "I just sold it so now watch it go up." I've found that not to be the case with the big droppers.
ANF is only one example, but a good one. The stock fell $0.70 after the stop and proceeded to make a new low. Again, there were some signals, which this time I decided to sit out. Why? Well, I tried a long one time without the RSI confirm, which means I wanted an RSI confirm for a second try.
Again, there was a small bounce and then the low was broken just before 10.45 a.m. at $20.80. Being stubborn there would have resulted in another $0.40 drop. If we go all the way back to the first stop, the stock was now down another 5%, or $1.10.
VEEV and BOBE wound up both being losers as well as the first trade on ANF this morning, but TNET pushed nicely off its lows some 10% higher. The move in TNET was almost three times the combined losses of VEEV, BOBE and ANF.
If you told someone you only got one out of four trades right, they would likely write you off. For some, seeing the first three trades stopped out for losses would have them on edge.
But if you can shake that off and use the notion of letting the winner(s) run while stopping the -losers quickly, this is a consistent approach. It can be repeated for small-net-gains time after time.
I've stopped out of the TNET trade, and now only sit with a small ANF trade, which I am trading based off the above chart. I will not carry any long via this approach past the end of the day.
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