Many traders become frustrated when a stock follows a pattern they deem to be illogical. Their frustration mounts when they take a loss do to this “irrational” pattern and they may actually trade against the pattern even after they have identified the correct way to trade the stock through rational observation.
DE had a large gap down after releasing their earnings report last quarter. I decided to trade DE as it was most likely going to be In Play. I lost a lot of money in DE that day. One of the main reasons was I got short when the stock looked weak and would drop support and got long when it looked strong and lifted resistance. Each time I opened a position it would reverse. Eventually I was convinced, based on its failure to breakdown below its intraday low despite an awful earnings report, that it would rally. And in the late morning that is exactly what it did. Unfortunately, I was unable to participate. I had hit my self imposed loss limit by trading against the pattern and had already moved on.
Flash forward three months. DE releases their earnings report and gaps down. One of our traders suggested at our AM Meeting that it would be a good stock to trade. During our discussion I mentioned last quarter’s trading pattern with the desk. And cautioned them to not short weakness or buy strength during the Open. And that perhaps for some it would be best to let the stock settle until it began a trend later in the AM.
Take a look at the chart below. You can see around the Open that DE reversed several times. I set a price alert below the premarket low of 29.65. My alert triggered soon after the market opened. I watched DE drop quickly from 29.50 to 29. I knew others on the desk were watching DE as well. I called out NOT to short it as it dropped 29 because of the possibility of a quick reversal. I made this call vocally because there is a tendency amongst traders, especially those who are less experienced, to open a position late in a move when the risk/reward is less favorable. They see panic selling or buying and want to hop on for the ride. But the reality is that panic often occurs near the end of moves and when it subsides a stock will reverse powerfully.
A bunch of bids were hit out at 29 in DE and it traded lower for a few seconds. I got long. Less than one minute later I was selling DE more than 50 cents higher. I shorted at 29.65 and within one minute I was covering at 29.20. This pattern continued during the first 30 minutes of trading.
As you can see from the chart below DE began to make higher lows and eventually broke to the upside in the late morning. Those on our desk were prepared to take advantage of the quick reversals on the Open and the trend that occurred later in the day. At SMB we believe that a fundamental part of being a successful professional trader is learning from our mistakes so as not to repeat them. But we also believe that the knowledge gained should be exploited for profits at a later time.
