PIVOTAL POINTS
Both Chris and I are asked frequently how we pick our stocks to watch. I would like to describe this process.
The major idea is to go where activity is. Several ways we use to find it:
1. In the morning our indication of activity is gap. When we find stocks gapping up or down, we look for a news that caused gap. We do not predict what happens to the stock after open. Purpose is rather to filter out those that are too dangerous (for instance, if stock has news including SEC investigation we are more cautious). Also, past experience and common sense might give useful hints. Simple example: FDA rejection would probably cause much harder reaction to the one product company than to company that has 5 other drugs in the pipeline. We also evaluate execution risk and filter out stocks with huge spread, big gap between levels etc (the way they trade might get changed when market is open so we still keep an eye on those).
Next step is detecting the trend. Gap direction is not necessary indicator of the trend. For instance, ADCT gapped up yesterday and shown clear downtrend since, which led us to several plays on the short side.
2. Intraday search for activity involves unusual movements and/or volume. When stock pops up on scanners as unusual mover it becomes a subject of interest.
3. Pivotal points. This is the most interesting subject since they have two meanings: first, stock approaching them usually becomes subject of readable activity and second, the way stock acts near the pivotal points defines the trend, allows to see if trend reverses or continues.
Those are intraday high and low, opening price, yesterday closing price. Also levels that are being watched by TA players, like 200 MA and some others. To some extent whole numbers might serve as pivotals.
Let me make it clear that we do not use these points to predict what stock does when approaches them. We use them as watching points and make our decision based on patterns stock shows. Let me site couple examples:
a) stock approaches yesterdays's closing price 25 after gap up. After some pause and upticking to let's say to 25 1/8 selling hits again and 25 level gets penetrated. We short the stock when it happens, setting the stop at 25 3/16 since stock couldn't get over 1/8 last time. Breaking down from the range as typical scenario is identified as a reason for entering the trade in direction of break.
b) stock approaches 200 MA level with increasing pace and volume, near critical level it looks like real panic. Furious selling pauses, and after some perplexity stock shows strength. We buy stock setting the stop right under level of support. Capitulation phase was identified as a reason for the trade.
So, algorithm looks like:
1. Finding area of activity
2. Identification of scenario
3. Putting on a trade when signal appears
4. Setting mental stop at the level that indicates scenario failure.
5. Monitoring the stock for exit scenario/signal
We plan to put some charts of actual trades called on our webpage with explanations and references to principles and scenarios applied.
Vadym |
