Trading successfully certainly requires a ton of patience and discipline. Emotions run high when it comes to your money and the prospects of losing it. Panicked selling is the easiest kind because you simply can't take the pain any longer. The best way to rid yourself of the pain is to let go of the culprits, right? Well, there are times when selling from an emotional state can be a good idea, but far too often it kills your trading results. If your stop is lost intraday and the volume is high, a big decision has to be made. A breakdown on big volume most definitely takes me to the sidelines. The problem, however, is that an intraday breakdown on heavy volume is a strategy market makers use to accumulate shares for themselves or their clients. You know what I'm talking about. I'm sure you've had days where you've sold a stock intraday only to watch it rebound miraculously in the afternoon with a major kick save and a reversing candle. Your sale marked the bottom, right? I've done it and I'm sure you have too. That's why I almost always use mental closing stops now. Here's a perfect example how this works - take a look at Broadcom (BRCM) towards the end of January:
We could spend an hour on this chart. There are so many possibilities. The first important question is where did you buy BRCM? If you chased a rally like the one identified in late December because the volume accelerated and you anticipated a breakout, you broke a couple of trading rules. One, you anticipated a breakout and bought at RESISTANCE instead of waiting for confirmation. Two, you were five days late on the entry. One week earlier, initial gap support was being approached with RSI (a momentum oscillator) close to 40 - generally a decent level to consider entry in a stock during an uptrend.
Now let's move on and discuss the action on January 29th. There clearly are two gap support levels that have provided support over the past few months. The gaps on November 12th and October 30th are nice support, as evidenced by the green lines on the chart. Prior to January 29th, we'd already seen multiple tests of those gaps held successfully. As a trader, let me ask you a simple question. Would you rather buy BRCM in the 40.50-41.00 gap support range or closer to resistance just beneath 44.00? Please don't answer this question wrong. :-)
You must understand the role of the market maker. Many times, the accumulation of shares occurs on an apparent breakdown. Why? Because with the loss of support, stops are triggered. Two things can happen from this point. Either market makers will support a stock and we'll see a miraculous recovery and reversing candle; or, the breakdown is likely for real and the selling will intensify into the close and likely continue in future trading sessions. The obvious question is "how can I tell the difference?" Well, to be quite honest, at the time of the low you can't. That's why your entry price is so important. If you had bought BRCM near support, the intraday low on January 29th would have resulted in a potential 1-2% loss on paper. That's palatable. Buying closer to resistance, however, would have resulted in an intraday loss of closer to 8%. That paper loss is much more likely to trigger the demons inside that result in a panicked sell. The bottom line is that a disciplined entry level generally results in a more stable emotional view during that intraday breakdown and a much more rational approach to the trade. So in this case, your decision to hold and await the possible late day recovery was enabled by the more disciplined trading strategy.
By the end of the day on January 29th, this looks like a strong BUY to me as we have a reversing candle (hammer) on heavy volume at major gap support with an RSI near 40. The action also suggests potential market maker involvement on the long side which provides me a lot more confidence in the trade. Generally speaking, market makers make money. The more often you can jump on their bandwagon, the more likely you'll walk away with a profitable trade.
Take a look at BRCM after the reversal and the ensuing February rally:
Listen, I know hindsight is 20/20. We could make a fortune trading off of hindsight. Unfortunately, we don't have that luxury so the next best thing is to learn from history and try to better understand the methodology behind market making. After all, the benefit of short-term trading is taking advantage of short-term market inefficiencies created by our market maker system.
This example stresses the importance of timing your entry. Many times your entry point will determine your intestinal fortitude when it comes time to selling, or the thought of selling.
Now let's have a little bit of fun. The red arrow on the chart above marks a GREAT time to sell. BRCM was just breaking out again so why sell? Well, I'll be back tomorrow to share my thoughts on that. In the meantime, feel free to leave your comments below as to why you feel it would have been a great time to sell. Also, please make sure you've subscribed to my blog at the right of this article. Under "Subscribe to this Blog", click on "Email Updates" and enter your email address. Then click "Subscribe" and VOILA! you'll receive my latest articles as soon as they're posted!
Happy trading!
Tom
