action is relative tothe information found in the time and sales ticker. They assess the ratio
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of buys to sells. They will look for two things. If the stocks have a ratioto the buy side, then they will continue to look for signs that the buyside pace is weakening.Should this occur and the stock stops in its tracks, they will look atthe sell side pace to see if it picks up. If the selling pace increases, theywill next look to see how much of the selling is being absorbed. As a stockclimbs and then pauses, many active traders will become impatient sellers, putting pressure on the downside. However, if true buyers are in thestock, the selling will be absorbed and not fall much. If traders see thisaccumulation of shares on any impatient selling and relative profittaking, they may want to continue holding the trade.At each level, they continually monitor this price action and beginto devise an exit strategy based on what they are seeing. One option thatmost employ is to sell a portion of their trade at a reasonable price leveland hold the rest for a possible move upward. This way they lock in theirprofits and hold the rest for more possible potential. After the first lot issold, they trail the stop on the rest if it continues to climb. For example,if the stock was bought off 20 for 2,000 shares and made a nice, slow climbto 21, then a trader may elect to sell 1,000 shares for a gain of $1,000 andhold the other 1,000 shares for a possible move to 22 or higher. If the stockmoves to 22, then the trader may elect to sell 500 more shares at 22 for again of $1,500 and hold the remaining 500 shares. This way a trader canlock in sure and safe profit while letting a bit more of the position climbfurther. Any signs of negativity that the stock may pull back moresharply and the trader will exit the trade with all shares, profiting fromtheir experience in watching such price action.The second trade is the pullback trade. As we discussed in the previous example, a stock under heavy accumulation may make a slowclimb with a few small pullbacks. Traders will do one of two things onthis pullback. If traders entered in near the bottom of the trade, they maywant to add to the position on pullbacks as long as the trade is performing to expectations. For example, if a stock bottoms off at 20 andmoves higher, traders may buy 1,000 shares at 20.06 or 20.13 and watchthe action. If the stock struggles to break 20.50, they may want to sell theirposition for a small profit. If the stock moves to near 21 on price actionthat is favorable for a small climb, then they may want to buy another1,000 shares on a pullback from a move over 21. This way they have averaged up on a stock that is performing nicely and meeting expectations.I never recommend averaging down on a losing position. I can’t seethe logic in buying a stock that is not performing to expectations.According to stop loss discipline, a trade is exited as soon as the reason
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for entering is no longer valid. This is not to say you can’t exit the tradeand re-enter at the next bottom. A stock selling down past your buy priceis a reason for an exit, not a reason to buy more in hopes that your average will provide an easier exit. The other way to play a pullback is forthose traders who miss the initial bottom but are looking for an opportune time to enter the trade without having to buy the highs.Suppose the stock moved from 20 to 21 under nice buying and accumulation and has paused. A trader will look for any selling pressure thatmay bring the stock back down to near 20.50 or 20.75 in which he or shewill enter the trade looking for a break of the high at 21. If the stockbreaks 21, he or she will begin to utilize the same strategy as the buy andhold trader that is in from a cheaper price. Otherwise, the trader may justexit the trade under 21 in the expectation that 21 will not be broken tothe upside. Basically, a pullback may be used to add to a winning position or to enter the trade with expectations of higher prices after the realbottom has been missed.The third type of trade from a slow momentum stock is the breakout play. This tends to be a trade more for scalpers in slow momentumstocks relative to active traders. I understand that breakouts can offerincredible returns for short-term traders. However, in relation to daytrading and momentum trading, breakouts are more for smaller, quickerprofits. The following section examines two ways a breakout play mayoccur.If you remember, we mentioned earlier that many traders watchMarket Makers throughout the trade to try and figure out an intentionon whether that Market Maker is a true buyer or seller. Once activetraders figure out the ax, they will often look for the ax to lift the Askprice higher after filling the client orders. Normally, an ax will lift his orher price after filling a large order. A big block at the Bid price or lowernormally crosses the tape at this point, signifying that the order is filledand the ax raises. At this point, traders may elect to enter the trade for aquick .25 to .50 point in expectations as buying comes in once they seethe ax is finished selling the stock at that price level.A breakout play may result from a new intra-day high being made.Using this example, if a stock moves from 20 to 21 and pulls back to 20.50and pauses again, then a trader may look for buying back to the 21 area.If buying and pace increases at 21, then a trader will elect to buy at 21 orbetter for the expectation that 21 will be broken. If 21 fails to break, thetrader takes a small stop loss. If 21 is penetrated, then expectations forthe trade are met and a trader will most likely exit at least half of the position under 21.50 for surest profits.
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Normally, breakouts move up a small amount and pull back sharply,forcing traders to be fast to enter and even faster to exit. Some of thesebreakouts over new highs unfortunately only move higher by .13 of apoint, disappointing many traders. However, most scalpers are tradingat least 1,000 shares, and .13 of a point profits them $125 for the trade, sothey do enjoy breakout plays.Slow momentum trades aren’t sexy and do not provide a lot ofexcitement. However, if a trader is to be successful for the long term,excitement should not be an emotion that he or she should chase afteranyway. Trading is about maximizing profit potential while minimizingloss. It should not provide excitement to profitable trades, nor should itprovide anger and frustration to a losing trade. This emotional rollercoaster is a big cause for a trader’s lack of clarity when analyzing a trade.This lack of clarity impedes a trader’s ability to learn and create a database of experience for how stocks move and the price action that theydisplay.
INITIAL PUBLIC OFFERINGS AND FAST STOCKSFast momentum stocks are the trades that draw people to trading. Fastmomentum inherently provides the battle between good and evil that somany traders experience when beginning to trade. Typically, fast stocksprovide great profit potential but offer a greater chance for sizable losses.The clearest example of a fast momentum stock that is dangerous to daytrade is an Initial Public Offering (IPO). We all hear how much moneytraders have made on IPOs. What they fail to tell you is that they weregiven shares at the offering price rather than at the price where the IPOopened. For example, ONI Systems (ONIS) was priced at $25 a share (seeFigure 5-3).Being able to participate in the stock at the offering price compensates traders who are big clients of institutions and spend a lot of moneywith them. Recently, online brokerages such as E*TRADE have been ableto offer shares to their clients through a screening process to allow greataccess to IPOs at the offering price. ONIS opened the day near $60 a shareand moved as high as $80 a share, which is nearly a 55-point increase inthe price of the stock from where the offer was. Traders in chat roomsand bulletin boards will scream about how much money they madeon the IPO. The reality is, however, that active traders need to knowhow tradable IPOs are after the stock opens for public trading. This meansthat we need to know how to profit from the trade as it moves from $60to $80.
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The reality is that an IPO is not an easily tradable stock once it opensfor public trading. As we watch highly regarded IPOs trade, they are fastand furious in the pace of the trade. The stock will trade nearly two million shares in a matter of minutes as institutions and active traders alikeare buying and selling the shares of stock. A stock that trades at nearly300 trades a minute is just too fast to obtain a desirable execution.I have seen numerous trades in chat rooms where traders place anentry or exit order on the stock only to see their actual execution pricemany points away from that desired level. We have seen traders lose 10to 15 points in one of these trades simply because of the poor executionability in many of these stocks. One would have to use an ECN to tradean IPO after it opens and even then, it is difficult at best to get a greatexecution price.Traders can forget reasonable execution prices on SNET and SOESas Market Makers are jumping all over the place on IPOs filling orders.Rarely do they stay on the Bid or Ask price for very long. This lack ofexecution reliability is what makes trading extremely fast stocks and IPOsafter they debut so dangerous. I liken it to gambling because a trader haslittle readability in the action of the stock due to the jumpiness of pricelevels. When a trader cannot read the stock and has trouble with the exe-
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cution of fair prices, then the stock becomes a dangerous trade that is bestleft to watch for entertainment.Sure, in some instances, traders can make some profits here andthere on IPO’s intra-day after they debut. However, over the long term,trading IPOs will cost more in losses than that in profits to your average trader. Do not let those who trade IPOs make you think they are easily tradable at the time they open. They are not. The pace is too fast andthe readability of the price action is difficult at best. Much safer momentum trades are available in which to participate.
NEWS ALERTSOne of the active trader’s most favorite fast momentum trades is the newsalert. News alerts are provided in real time mainly by a news service suchas Bloomberg, Dow Jones, Comtex, PR Newswire, or Reuters. Some services such as NewsWare Inc. provide access to most of these at once sothat traders can have the news scrolling on their screen while they aretrading. Once a bit of news catches their eye, the traders bring that stockon their Level 1 and Level 2 screens, assess the risk and reward scenario,and then execute the decision according to their expectations. This is justone more example of how real-time interactive data can provide activetraders with more power over the Internet than they ever had before.News alerts are generally faster plays as well. Scalp traders look toenter the stock at the price when the news first comes across the wires.After they enter the stock, they look for late-to-the-party momentumplayers to bid the stock higher. As the stock rises, the scalp trader willexit the trade into strength from usually no more than 1 point in profits.Sometimes the stock will move higher, sometimes not. This is the benefit to exiting into strength. A trader is assured to exit the stock when hewants to, not when he has to.A typical news alert trade will occur in the following manner. Let’ssay that at 10:30 A.M. EST, stock XYZ announces a three-year, $1-billioncontract to provide Microsoft with software support. This news headlinecomes across several wires such as Dow Jones and Reuters. Activetraders see this information and begin frothing at the mouth. They pullup stock XYZ on their screen and find the stock is trading at $7 a share.Many traders will quickly assess the risk of the trade by looking atthe Bid size in case the stock does not begin to get buying. They want tomake sure that any impatient selling won’t cost them a fast 1⁄2 to 1 pointin losses if they are wrong. They will look to make sure the price levels
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are fairly tight of no more than .15 in spread. They will also look at thechart to see if a price spike has already occurred and whether or not thestock is already up on the day, signifying that the news may not be fresh.Furthermore, they look at the volume to see if the stock has a substantial volume or not. Remember that volume is important in assessinginterest and momentum potential in a stock. If a trader sees a news alertand the stock already has 2 million shares traded but a narrow intra-dayrange, it may tell them to lower expectations for the potential in the tradeas it may take too much buying to really move the stock higher. A common mistake that many traders make also is to assume that when theybring up a news alert stock and the volume is low, that the stock will notmove. I tend to think in the fashion that low volume means the news maynot be out yet and it may provide a reaction soon. The other side of thecoin is that if the news is out and the volume is low, then no one caresand the stock will more than likely not move. This is the importance ofbeing able to assess a stock’s potential once the news alert is given. Activetraders who have been doing this for a while are able to do this as fastas their software can bring up the information in front of their eyes.A split second later, they either buy the stock at the Ask or decideto let it go. In most cases, they do not try to enter the stock at the Bidbecause the chances that someone is selling stock will be much less. Also,they do not chase the stock as it is rising because more often than not,chasing a stock will result in buying near the top of the price spike, lessening the profit potential. If a stock is bought a .50 point higher than theprice at which the news was alerted, then they are giving up much of thepotential, assuming the highest expectation for the stock to rise is only1 point. This is what differentiates a trader who is playing highpercentage news trades or low-percentage. I only enter trades that arefresh and only if the stock has not reacted to the news yet.Once a trader enters this trade, this is where external forces comeinto play that are quite interesting. First, the headline itself is catchingthousands of traders’ eyes. Remember that although active traders maynot be able to move overall markets, they can certainly have an effect onindividual stocks. As thousands of traders see the headline and react,trades begin to occur and the time of sales prints begin scrolling. Volumeincreases and the pace of the volume quickens. This shows that interestis present and the stock has potential to reach expectations. The hype andcomments that follow in some of the free chat rooms is quite comical andit is very easy to spot the amateurs from the professional traders among
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the hypers. However, the adverse effect of what happens is that newertraders buy into the stock on the excitement generated in the room. Thisis when they end up buying the stock near the top of the price spike, causing them frustration and losses.Traders who are currently in their positions will hype the stockincredibly to newer traders. You can often hear comments like this:“This news is incredible. This stock will go to 50 in no time.”“The long-term chart is great on this stock. There is very littledownside and tons of upside.”“This is a buy if I ever saw one.”“This is your last chance to buy at single digits.”“VOLUME alert, this stock has momentum and ain’t stopping forno one.”
AMFLY
“Ooooooh, baby, this one is going to fly!”Here are the comments from room leaders:“Congratulations to those who bought early. We always get thembefore the market does.”“The market is finally waking up to the news and they like it.Whooo-hooo!!”“Here comes 8. At least 10 is in the definite future and I wouldeasily expect 20 to be hit in the next few days.”“I’m posting the whole story because this news is great. Just readit and you will understand.”
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From this scenario, a trader must be aware of a few things in orderto not get caught buying at the top of the price spike. Anyone who is consistently hyping these stocks is not a professional trader. They are amateurs or they are room leaders that have enough knowledge tounderstand that if they continue to hype the stock, enough momentumfrom the members will allow them a better chance to exit the stock withthe surest profits. The rest of the members are entering and getting stuckin at higher levels as the stock is falling.Professional traders will quietly enter the trade, watch the priceaction of the stock, and watch the hype that is providing extra momentum that they can exit into on the buying strength. Then they quietly exitthe trade and move onto the next trade or wait for a reasonable pullbackto enter again. One thing to be looking out for is a stock that is being
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repeated over and over again by a room leader or a specific trader. Theyare clearly in the stock at lower levels and are trying to entice more buying from those who follow them in hopes that they can exit to the flockof late buyers.These subtle forms of hype will only get better and more organizedas the online revolution evolves. It is up to us to really challenge ourselves to ask what the underlying reasons are behind these comments.Question them openly if you feel they are doing anything that may misrepresent the true intentions to a stock trade. News alerts are a great formof trader momentum by which a trader can profit. However, traders needto be aware of plenty of instances so they do not get caught buying thestock near the high of the price spike.Just as in slow momentum stocks, pullbacks on news alerts are alsoa viable trade in which active traders can participate. For example, let’sassume this stock moved on the news from $7 to $10 on the momentum,allowing traders to clearly exit into strength along the way. The first cautionary point to this move would be from those who were caught chasing the stock further away from $7. The $3 move will entice traders tochase the stock the next time they see momentum. More often than not,they will get stuck at a price level that serves as resistance. Therefore, theywill couple their frustration of missing the move on this stock from $7to $10 with the stop loss taken on the next play as they bought the topof the price spike.It is impossible to tell with 100-percent certainty where stocks willmove to on a news alert. Therefore, you must buy nearest to the price atwhich the stock was alerted and exit into strength as the stock climbs. Ifyou chase the stock higher with the rest of the late-to-the-party buyersor exit when you have to instead of when you want to, then you will findyourself frustrated with less profits than you would have liked to take.Assuming our stock moved from $7 to $10, then traders will be looking for a pullback on the stock that will offer a scalp trade. Normally onthis price range, they will look for a pullback on the stock to near 8 3⁄4 to9 for a scalp trade. This provides them with enough potential to theupside of about a .25 to a .50 point in potential. On 500 to 1,000 shares,in their minds this is more than enough profit potential to risk a trade.If the price action at this area does not look promising and looks to fallfurther, traders will get more interested.A move to $8, for example, would bring in traders expecting .50 to.75 of a point in potential based on the momentum. Not all pullbacktrades offer this potential, but normally, if the momentum from $7 to $10
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was strong, then willing buyers should be present to provide anothertrade off a pullback level. Later when we discuss oscillation plays, wewill discuss how to spot pullback bottoms. The final comment I want tomake on a news alert pullback play is that once again, you will hear comical conversation in the chat room and on bulletin boards regarding thispullback. For example, we may see these comments:“This news is weak. This will be back to where it started in notime.”“I do not see why people think this stock is going anywhere. Thatnews was nothing exciting.”Two possible scenarios invite these comments. The trader missed themove altogether and has to explain to him- or herself why he or she wasjustified in not getting in the trade. The other is that he or she is now shortthe stock and is trying to panic late-to-the-party buyers into selling thestock and hopefully providing more downward pressure. Those who arestuck in the trade at higher prices are providing comments of why weshould buy the stock again. Either way, be careful of comments you seein these chat rooms and on bulletin boards.Push yourself to think about the underlying reasons why suchcomments are said. Remember, most professional active traders are thesilent majority simply playing the stock based on what they are seeingand not what they are hearing. They do not need to continuously talkabout a stock in which they currently own a position. If the trade is toperform to expectations, then their intelligence and trading acumen willprove them right. Hyping the stock will not. If they are wrong, then theytake a stop loss immediately. They do not provide commentary that triesto entice buying so that the stock returns to a level that they can exit atagain. The more traders talk in the rooms about specific stocks, the morethey seem to uncover their true intentions. Realize these intentions andprofit from them, rather than become a victim of the trade.I have discussed in this chapter the ability for momentum to provide predictability. I discussed the potential for slow and faster predictability as it pertains to a few different scenarios. In the next chapter,we will discuss a few niche patterns that I have been tracking, following, and exploiting for years. For now, understand that the pace of thetrades relative to volume and price movement defines momentum.Lower volume will lessen the predictability. Traders must be cautious ofwidespread, low-volume stocks for safety. They tend to cost more in stoplosses than profits to both newer traders and experts. More experienced
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traders are able to possibly profit by splitting the spread and reading themarket participant intentions. However, in the beginning, it is best tostick with more liquid stocks that have a reasonable pace and good volume for safety. When assessing a trade, do not be fooled by the hype inchat rooms. This hype is posted for their own benefit, not yours.
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PREDICTABLE PATTERNSOver the years, I have identified, tracked, and exploited a few niche patterns that tend to repeat themselves over and over. Although these patterns don’t always repeat themselves in the same manner, they do a goodpercentage of the time. The key to high-percentage trading is identifying what will happen a good percentage of the time and exploit it to thefullest. Too many traders simply jump on stocks that are moving without a game plan. A lack of a game plan tends to overwhelm traders dueto the large amount of data they are required to absorb in short periodsof time. If you know what a certain pattern will do a good percentage ofthe time, then you increase your winning percentages.The purpose of this chapter is to point out four predictable patternsand discuss them at the basic level. You will learn how to identify them,track them, and predict their movements. The next two chapters will takean advanced look at all the factors that can influence these patterns atthe macro level, which include the indicator method and the overalldynamics of the market. For now, simply follow along and learn torecognize the patterns and understand their predictability.
NICHE PATTERNSI track and play four niche patterns: gainers, dumpers, end-of-day gaps,and news plays. Gainer patterns are stocks that are up 20-percent or morefrom the previous day’s closing price on good news. An example wouldbe a company that releases a favorable earnings report or is upgradedby an analyst. If reported after the bell, the stock normally gaps up thenext day. If the story is very strong, following the gap up, it either sellsoff a very small amount and then moves upward or simply takes off atCopyright © 2002 by Mtrader.com.Click here for Terms of Use.
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the opening bell without a dip. We buy at the first dip or sell off and ridethe momentum up.If the story is weak and the street overreacts as they normally do,we short at the first high and wait for the street to digest and understandthe news. Then we exit after the downward momentum slows.The dumper pattern is a stock that is down 20-percent or more fromthe previous day’s closing price on mediocre bad news such as missingearnings by 1 cent. I play the bounces the following day as the streetrealizes they have overreacted to the news. I only play mediocre badnews and not devastating news such as huge earnings misses with companies that are dying or are dealing with SEC investigations, fraud,or bankruptcies.End-of-day gap plays can be either dumpers or gainers. I watchthem in the last few minutes of the day, looking for building buying pressure along with several other indicators that will drive the price higher,causing the stock to gap open (open higher than it closed the previousday) the next day. An added risk exposure exists to holding stocksovernight, but, given the proper circumstances, it can be worth the risk.I touched on news plays earlier in the book, but I scan the news allday long and wait for a good story to hit the wires. An example of a goodnews story was when ValueJet was cleared to fly again or when Ion LaserTechnologies received FDA approval to market their painless dental laser.A real talent is involved in playing news plays and several pitfalls canoccur, which will be discussed in the “News Pattern” section.The momentum that causes these patterns tends to move stocks ina very predictable manner for the next two days, time after time. If youare able to identify these patterns, you can exploit this predictablemomentum. They don’t always react in the same predictable manner, butthey do a good percentage of the time. However, unless key market variables are in place, the patterns will not react predictably. Chapter 7,“Indicators,” and Chapter 8, “Market Dynamics,” will give you insightas to exactly which variables affect these patterns and how to properlyplay them. In this chapter, I will explain these patterns without describing the influence of these two variables. So keep in mind that these twochapters go hand in hand with this one. Let’s examine the patterns oneat a time.
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GAINER PATTERNThe first pattern is what I call the gainer pattern. As I said previously, itis a stock that is up 20-percent or more from the previous day’s closingprice on good news (see Figure 6-1). You can play a gainer that is up lessthan 20-percent, but the predictability factor decreases. Gainers aredivided into two groups: first-day gainers and second-day gainers. Firstday gainers receive positive momentum the first day and on the secondday after the initial move, they become second-day gainers.I first identified the gainer pattern when I saw stocks moving oninterest by active traders when particular positive news events werereleased over the news wires. The basic theory behind this has dated backto the beginning of the market itself. Stocks with good news would orshould rise. The more interest in the buy side of the stock, the higher itshould move.F I G U R E
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Those traders who bought the stock before or just as the news cameout would benefit by the climb that the late buyers would produce. Theearly buyers would sell to the late buyers for a nice profit. The late buyers would buy the stock normally near the top of the price spike and theprophecy of “the public is usually wrong” continued to hold true. Thesmart money is in from a lower price, whereas the public is buying sharesbeing distributed to them by the smart money from lower levels.The type of news that I looked for early was information such asFDA approvals for a new drug, upgrades, or earnings estimates raisedby analysts, and the inviting cancer cure. This type of news draws interest from active traders and would normally propel the stock higher. Inthe past three years, I have seen some incredibly new concepts thatpropelled stocks to amazing heights. Back in 1997 and 1998, if a companymentioned that they were going to put up a Web site, the stock had aninstant reaction. If a stock announced they were involved in deals withthe likes of Yahoo Inc. (YHOO), eBay Inc. (EBAY), or Amazon.com(AMZN), the stock would gain immediate interest. I saw incredibleclimbs in stocks such as Books-a-Million (BAMM) and Multiple Zones(MZON) on this kind of news. Traders who played the pattern on thistype of news did very well with a lot of multi-point potential.In 1999, we saw the likes of news interest derived from Linux,Business-to-Business (B2B), and China plays. The onset of the Linux software market propelled stocks like VA Linux (LNUX), Red Hat (RHAT),and Corel Corp. (CORL) to new highs. The Business-to-Business (B2B)sector gained momentum in stocks like Ariba (ARBA), PurchasePro(PPRO), and CommerceOne (CMRC). The expectations of the China market to be opened to the world through its initiation in the World TradeOrganization propelled stocks like Qioa Xing Universal (XING),China.com (CHINA), and China Prosperity International Holdings(CPIH) to new heights. Stocks like Qualcomm (QCOM) also benefited bythe possibility of China adopting its CDMA technology. Just the wordsChina, Web site, Linux, or Business-to-Business in the headline wouldattract immediate interest.The more comical issues we watched in 1999 were the Pokemonrelated stocks. 4 Kids Entertainment (KIDE) and Grand ToysInternational (GRIN) both made incredible moves in just a few monthson announcing relation to the Pokemon craze (see Figures 6-2 and 6-3).Children were trading these Pokemon cards everyday like the nostalgicbaseball cards of the past.
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In the year 2000, we have seen interest in some concepts such as FuelCells and Genomics stocks. The Fuel Cell interest fueled runs in stockssuch as Ballard Power Systems (BLDP), Electric Fuel Corp. (EFCX), andFuel Cell Energy (FCEL). Genomics stocks were hot as the mapping ofthe human gene project was in full swing. Human Genome (HGSI),Genome Therapeutics (GENE), Cell Genesys (CEGE), and Protein DesignLabs (PDLI) continued this same sector enthusiasm. It has been anincredible year so far and we continually await the next craze that willcreate this interest and profit potential.The evolution of the gainer pattern from simple headlines of positive news such as an upgrade or FDA approval has adapted to the changing market to include hot sector plays such as the examples describedpreviously. It is important for traders to understand when they are hotand when they are not. If traders were still trying to play the Pokemonheadline, they would certainly be losing money today as the interest haddied in this group.
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THREE BASIC ELEMENTSThe three basic elements to the gainer pattern are positive news,reasonable pre-market volume, and a price gap to the upside. Eachmorning I gather news from the after-hours headlines from the previousday as well as the current pre-market morning news. If I find stories ofinterest, I put these stocks on the Level 1 screen and monitor their premarket action. Specifically, I am looking for trader