RIMM has been my favorite trading stock for the past year or so. I have blogged about trading it a few times already. On Friday it presented a phenomenal trading setup. A setup that I believe works over 70% of the time and offers a risk to reward of greater than 10:1. This setup does not occur that often but it is a trade that I want to make 100% of the time. I am somewhat annoyed that I failed to put this trade on as I had highlighted it during our AM Meeting on Friday. Guess I’ll have to cut back on the million share plus trading days so I can be more mentally alert 🙂
The setup involves a stock that has shown great strength recently. It blows through a longer term resistance level which is shortly thereafter followed by massive profit taking. The next day if things fall into place there will be a great trade on the short side. The following must occur: 1) On Day 1 the stock must Close significantly below the recent resistance. 2) The stock needs to gap up on Day 2. 3) The stock must trade up to or through the recent resistance level on Day 2. 4) The stock must either fail right at the resistance level or drop below it after very briefly trading above it on Day 2.
If you look at the two day chart for RIMM you can see that all of the above criteria were met. On Thursday there was massive profit taking as RIMM blew through the 75 level on the downside. It bottomed below 72. It actually formed a reverse head and shoulders pattern with the neckline at the 73 level. The great thing about that is that many traders look for reverse head and shoulders to get long so RIMM had a good chance of being pushed to the 75 level on Friday which would provide us with the price we needed to open a short position.
As you can see from the chart below RIMM failed to hold above 75. After dropping the 75 level it traded down almost 4 points in the next 30 minutes. There were two chances to enter the short at the 75 level. On the initial break below 75 you could have hit the bid or you could have entered the short when it briefly popped back up to 75 and failed.
Initial downside target would be the 73 level from the prior day’s reverse head and shoulders pattern. Second target would be 71.75 which was the prior day’s low.
I think this trade works really well from a macro perspective because so many momentum players are long RIMM from much lower prices. When they see the six point down move on Thursday they begin to think that the RIMM party may be coming to an end. So the gap up on Friday gives them a great opportunity to exit their positions at a favorable price. You also have some who were caught getting long RIMM above 75 who were very happy to scratch the trade when it traded ever so slightly above the 75 level.
On Monday I will have alerts set for 73 and 75 to see how it trades at those levels. Weakness at either price will get me short.
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