Bella received the following email from a blog reader today
Dear Mike,
Thank you for an OUTSTANDING book. After studying the information within I now feel like I have a framework for improving my skills with each trade, every day.
Steve talked about trading the retracement high today on stocktwits TV today. Could you please explain in more detail and maybe provide some examples?
Thank you very muck for your time and attention,
Greg
Let me try to answer your question Greg. I think you were referring to the question I attempted to answer from @thearmotrader regarding his trade in AMZN today. By the way I thought his trade idea was excellent. He found a market leader that had recently been beaten and decided to get long after it pulled back from a very powerful opening drive.
A common way to manage your risk on a trade that has a strong opening drive is to use the retracement high/low as a price to place your stop. In the case of AMZN it retraced to 166.80 after topping out at 169.20 on its opening drive. Once it began to consolidate above 166.80 it became a good long candidate and provided a very easy way to evaluate your risk/reward. The morning high was $2.40 above the retracement low, so if you were to follow SMB’s risk/reward rule you could risk up to 48 cents and still maintain a 1:5 risk/reward ratio.
If you got long AMZN fairly close to 166.80 you would be completely justified in giving it to below 166.50. 35 cents of risk on a market leader that had a huge opening drive on above average volume with more than $2 of upside to the intraday high is an A trade in my playbook.
One Comment on “Traders Ask: How Do You Use The Retracement High/Low?”
Steve makes some great points about identifying risk/reward in the trade and using that to evaluate the quality of the trade, but I’d argue that that’s the easy part of this trade. Identifying the 166.80 level in real time is the hardest part. So how do you do that? I’ll run through how I played this trade.
Amazon’s daily looked really ugly. 166 was a pretty hard line in the sand and AMZN didn’t even blink running through that in the morning. It was actually on my radar for a short, when it pushed back up to 166, I got short. It was going well, until it wasn’t :). I took an 11 cent loss from that. I flipped my bias long when I saw a buyer at 166.36 and bought at 166.50. I sold that at 168.60 when the trendline broke… Now I’m in wait’n’see mode.
I start by drawing a Fibonacci retracement on the 163.9 to 169.27 move. Before Adam hunts me down for using Fibonacci levels, I only recommend to draw them so you can quickly gauge how far the stock has been retracing. That can quickly tell you your risk/reward and the overall health of the pullback. My favorite pullback trades find buyers between the 38.2% and 50% levels.
If you just bought at the first sign of a buyer, you’d have lost a lot of money. 168.30 & 167.75 & 167 looked like there might be a held bid, until it dropped.
A lot of people like to wait until a 5 min reversal candle appears. That actually worked relatively well here. You’d of gotten in at 167.30, but even if you put your stop at 166.80 (making the trade 1:4), you’d still have been stopped out.
The method I used was to draw a trendline against the 1 min chart. Then I waited for volume to confirm the break. My official entry was 167.15. I noticed 166.89 seemed to be holding well, but the SPY looked like death at that moment so I didn’t feel comfortable getting in yet.
I ended up jumping ship at 167.30 when a lot of seller volume came in and pushed through another 1 minute trendline I’d drawn. However, the story does have a happy ending. When it started to consolidate around 168 and 167.75, I got involved as it pushed through 168. I sold when it fell below 169.24. The volume had dried up and the SPY was at the upper bollinger band, so I was expecting the weight of the market to move Amazon sideways or back down the rest of the afternoon.
To recap. I used the 5 minute candles for any reversal signals, but more importantly I used 1 minute trendlines. When volume and a held bid confirmed the break, I got involved.