There are several setups for intraday traders that offer the greatest risk/reward. An essential part of our job is being able to identify these setups and not to abandon them if they fail to reap a reward initially. One such setup was offered in CAT this past week. CAT gapped down on abysmal earnings. It spent several days flirting with breaking down below 32. But it just wouldn’t break down. The first few times it dropped 32 it wouldn’t stay below for very long. And on Thursday when it finally cleanly broke below 32 it only dropped 30 cents. 31.70 became a support level.
There were several traders on the desk who got ripped up around the 32 level. All of the bids at 32 would get hit out so many traders would get short to play the momentum. But CAT would trade back above the 32 level every time. At this point as a trader you need to make an adjustment. You can no longer short CAT unless it trades below 31.90. You need this extra confirmation of the downward momentum before establishing a short position.
Some might ask why I would continue to maintain a short bias in light of the fact that CAT failed to break down for several days. The answer is simple. One, stocks that gap down on poor earnings and fail to bounce significantly that day trade lower in the trading days immediately following the gap down. Two, stocks that consolidate near the low after a large gap down usually get hammered once they drop below the consolidation range. Three, under current market conditions stocks that are set up to trade lower do so over 80% of the time.
On Friday, CAT opened below the 31.70 support. After briefly popping above 31.70 it dropped to 30. I have to admit that I missed this trade. It would be easy to say it was the end of the week and I just wanted to focus on AMZN. But the reality is that I had been waiting for CAT to break all week. I should have seen that it was opening below 31.70 and set an alert for 31.70. When it failed to stay above that level I could have put on a small short position since it wasn’t my primary stock for the Open. The first time I looked at it on Friday was at 30.10 when my alert that I had set earlier in the week was triggered. I set that alert on Monday expecting that when CAT eventually broke hard below 32 that it wouldn’t stop until 30.
At the end of the month if you fail to make these high reward low risk trades your results won’t be nearly as good as they should be. It is understandable that some may become frustrated if their setups don’t work as planned initially. The proper response is to make the adjustment to your plan and put the trade on when your new criteria are met.
