DrStocks

Facebook (FB) Stock : Shorts in control

I once had an FB account.  Then one day FB tried to force 'Timeline' down my throat and I said 'I've had enough'.  I was already fed up with their erratic and often user-unfriendly, twice-a-week site makeovers and the timeline feature was just the last nail in that coffin.  But personal prejudices should not come in the way of making trading decissions, so, today's post is going to be a technical overview of the FB stock as it stands at 12:30 PM on 7/17/12.  

Looking at the daily chart you can see that after the huge IPO failure the stock touched a low of $25.52 before bouncing back to ~$33.  Then it started its slow oscillation with a tentative double top formation, albiet a bit sloping (top of the channel).  Now, the interesting thing to note is that no big news have come out in the recent past and the oscillatory stock price was a tell-tale signature that the shorts were just waiting to pounce back.  The $30 price level was a psychological mark - any round good looking number is, by the way - and I decided to short only after a daily candle would close below that mark.  I was getting ready because I knew that before their first earnings release there would be enough uncertainty to push the price below this level - at least the shorts would make one bid at it.  Once that was taken care of  it should be a no-brainer till $25.52, the June low.  An interesting question to ask would be why I did not short when the bearish engulfing candlestick pattern formed, right after the double-top (A).   That could indeed be an ideal trade for some, but I had better plays to deploy my capital at that time.  With FB, I was only looking at a channel trade worth less than $2 because as long as the stock did not breach $30, you could not have counted on it to do so! DUH, but true! Instead I decided to wait and watch till it broke $30, a psychologically significant number, when I would be more confident of the price hitting the $25 level, thus generating greater reward fort a lower risk.  The 'lower risk' part in the last sentence was not used flippantly.  With a sharp breach of the $30 level (like we saw yesterday) you can be sure that your entry is shielded with a very strong resistance above your selling point.  But near the point marked 'A' you do not have a well defined resistance.  The channel top was just beginning to form and the stock might have made a bid for $34 and a whole lot of uncovered ground above in the coming days.  Although one might argue that the low volume was a dead giveaway that it was headed lower rather than up, you have to pick your battles in this game and I had better ones.

A small reminder at this point.  I use a combination of chart reading and news and that is how it should always be.  Chart reading is nothing but reading the mass psychology which in turn is governed by news and views.  So if you look at a chart and try to put it in context of what impending news can move the stock, then you are approaching the problem from a more holistic viewpoint.  The stock breached $30 decisively yesterday and I shorted the open today.  But the next big question is how low will it go?

To answer that from a technical perspective we need to keep in mind the important level of $25.  No matter whether it goes down further, which looks very likely, that level will definitely be where the shorts are looking to cover.  A perfect double bottom would be obviously at $25.52. Also keep in mind that shorts would likely cover before earnings in order to avoid any unnecessary risk from surprise announcements (like FB announcing toddler accounts !) during the call.  Also, the bottom of the channel (in red) was made to make it parallel to the top with only the June low serving as an anchor.  This is not the usual way to draw trendlines but sometimes it gives an early warning of what is to come.  It could so happen that the downward trend continues all the way to $23.5 instead of bouncing back from the $25.52 level.  And the most unlikely scenario would be  the stock  cut through all these and move straight towards the $20 level. This is extremely unlikely before the earnings but if the earnings dissapoint (the already depressed expectations) then FB could really touch 20$.  But for now I will keep a sharp eye on the $25 level and cover at the slightest pretext.  Only extremely bearish candlestick moves would pursuade me to keep the position open below $25.  

Also, keep in mind one thing - you are only trading possibilities, not absolute facts. So always be ready to take cover, run and hide whenever the tide turns against you.  No long term promises, no short term losses.

 

Disclaimer: Please click the 'Legal' tab in the main menu at the top.

Where is the stock market headed?

Honestly, I don't know.  Even more honestly, no one knows.  But I am getting very uncomfortable just by looking at the signs.  Yes, the signs.  Because that is all we can do.  I will keep this brief - I think the stock market is in for some serious plunge in the next few months.  

Lets look at the S&P 500 index weekly chart.  We see a perfect head and shoulder formation within an upward trending channel.  The second shoulder started forming when the index bounced from the level where it was at the beginning of 2012.  The collective wisdom of all the market players decided that it had gone down low enough and some buying followed that fuelled a  month long rally.  But the fuel seems to have dried out and a well defined shoulder is slowly forming.

Now what are the two big events in the near horizon?  Earnings and election.  Let's for a moment consider that Europe will be Europe for the next few months - a slow release pill of doom and gloom, but nothing too catastrophic.  Alcoa stock losing value yesterday after the slightly upbeat earnings report tells us that the market is not very optimistic at this stage.  We have also heard that the technology companies are issuing cautious warnings about a poor Q3.  So unless the quarter is stellar in some other sector, it is likely that the shoulder will  grow into a perfect 'body'.  

And isn't it coincidental,  that so far it looks like the S&P 500 is going to go down 10% to 1200 levels by November? Just saying - watch out folks, there are sharks bigger than you can even imagine!

 

Shorting NSPH: A lesson in timing

Today's post will be a quick reminder of how important it is to time your perfect trade.  Well, timing is an ambiguous word because it somewhat depends on the time frame you are trading in.  So if you are a long term swing trader you would not care if you bought 10-15 points away from the best entry because your reward target is much more.  But for  an intraday trader those 10-15 points could well be the chunk of his target.  As I am an intraday trader who sometimes holds his position overnight, my posts would more often than not cater to this group of traders unless mentioned otherwise.

The anchor stock for today's discussion will be NSPH.  It has been creating new highs and showing extreme strength over the past few days.  As is often the case with such stocks, they tend to leave huge gaps on their way up.  Gaps can prove as effective speed breakers to a stock's ascent because they are essentially created by price increase on low volume.  Extended hours trading creates these gaps and the low volume make them vulnerable to price retraction.  So, more such gaps in a chart, more likely the stock is likely to retrace and 'fill the gaps' - a term often used by traders.  So looking at NSPH you can tell the stock was ready for a retraction.

 

I was waiting patiently and then suddenly I got the signal - a thick red candle (figure below).  I let the candle close and shorted as soon as I saw that the next one was also going down (@ 3.12).  I found that the candle had breached the 50 MA decisively and thought I was sure that I was shorting this with surgical precission. I was wrong and I have been similarly wrong before.  Look at how the stock retraces back to the 50 MA before slowly bleeding to a close nearer to my basis point. At the end of the day (yesterday) I had zero profit.  I am still short and net positive now, but the lesson is this - never buy right after a huge dump near the top.  It is always good to think like a counterparty and how he is looking at the same dump - a buying opportunity.  So wait for it to retrace and then take your position.  The ideal short position should have been initiated after the price failed to close above the 50 MA in the 15 min chart and the subsequent bearish engulfing pattern. 

I usually have a low tolerance for stocks which do not go my way right after I take a position.  I made an exception because of a few reasons.  First, the overall market was down with no signs of a bullish close therefore limiting the upward potential and hence my risk. Second, retractions look for hitting whole numbers, $3 in this case, so I knew I would have a second chance. Third, the failed move above 50 MA showed that the stock had really lost its strength and is ready for a sustained downward move. And finally, the huge gaps would act like a magnets pulling the price down.  Currently I am short NSPH and it is hovering around $3.01.  I predict that it will close below 3 most likely between 2.85 and 2.90. Tomorrow should be another down day and I predict this stock hitting 2.5, close to which I will take profit.  Remember, none of this is written in stone and I re-evaluate my target with every passing candle but even then you cannot afford not to have a plan - otherwise you will be like the proverbial bull in a China shop.  

As I write I see the $3 mark gets breached. Rinse, lather, repeat! 

Full Disclosure: Do your own due dilligence.  This article is meant as an educational material and should not be used to open/close positions in any stock.  I am currently short this security.

GEVO: An ideal short?

Once in a while you come across a chart which begs for a closer look.  GEVO was one such which I stumbled upon while on my weekly chart hunt.  Even at first glance you know that something is going on behind the scenes - the spike on 6/20, the two big dumpings exactly a week later on 6/27 and 6/28, the high volume but small recovery on 6/29 and finally it looks like the stock price is headed lower. Unlike a regular chart, this one clearly has been governed by news.  So it was time to dig deeper.

First, I tried to nail what had caused the spike.  A little search revealed that it rose on the news of a favorable ruling on a patent infringement suite filed by a competitor . Next, I tried to trace the reason behind the big drop.  More snooping around revealed that  the plummet was a result of the announcement of a secondary offering .  Investors grow skittish whenever there is such an announcement because they are now unsure at what value the stock would be priced though it soon gets priced in (the two red candles).  It seems they did not have to wait for long because within two days they declared the price of the offering was at 4.95.  That is when you see the huge volume but without price increase because there were a lot of shares on the offering at that price. Now the interesting part.  We see a distinct wedge developing that shows the stock has more headwind to weather.  On 7/6 the court rules against GEVO on the patent infringement suite and the price seems to be breaking further.  Now without going into the merit and details of the court rulings can you predict whether the price is going to tank further? Yes, you can and I will tell you how.

First, what are the two events that are pulling down the stock?  Secondary offering and unfavorable court ruling.  The secondary offering puts a cap on the upward potential.  Look what happened to AVNR in Nov, 2010 when they issued a similar offering.  

The stock price tanked for a whole month following the offering and made an unsucessful recovery attempt.  The two offerings are comparable (even the underwriters are the same). Also both of these had, as is usually the case with such offerings,  one whole month following the date of the offering when the underwriters can sell stocks to absorb demands.  So one can logically argue that the constant supply of share at 4.95 is going to generate a  downward pressure on the stock price, very similar to what we saw with AVNR.  Now here we have an additional news - that of the unfavorable court hearing.  This is what initiated the breaking from the wedge.  The two wicks of the candles on 6/29 and 7/6 form a sharp resistance at 4.74. So the question then becomes - what are the odds of a nosedive.

 I would say plenty.  The secondary offering provides a downward pressure.  The unfavorable ruling a catalyst.  And the chart is just waiting to break down - closing at an all-time low and a strong downtrend and subsequent wedge formation signifying a potential downward move.  Round numbers provide nice supports so we can safely assume that there is a 10% downward potential till 4.  I would wait to see how it opens and if it gaps up and then retraces sharply from 4.74 then its a slam dunk at that level because you can be pretty sure that the stock ain't gonna bust 4.95 anytime soon therefore giving you a nice stop loss target with ~70 cents reward target.  

Full Disclosure: This is among a list of stock in which I might initiate a short position on 7/9.

 

Stock trading tutorial - Why it is right to be wrong sometimes!

In my last post I mentioned how not having an opinion helps a trader.  That is a loaded statement and I need to elaborate.  It does not mean you should not have any opinion at all about a stock's price action. In that case you are better off having dinner at Vegas.  Instead, what it means is, it is okay to have a working hypothesis for a stock and its price action - but your hypothesis/opinion should not be put on a pedestal, to be revered and worshipped.  Instead you should be ready to break it down and build a new one on the slightest pretext.  You should be open to signs from the market and make as many hypothesis as possible from different angles and stick with the one which seems to be working at the moment but ready to shift gear whenever necessary.  I will explain this with the trade I made yesterday.  I still have that position open so we will  eventually see how it went.

 

I caught the stock one hour into the morning session around 10:30 EST.  I found it to have risen strong earlier only to give back half its gain before consolidating and looking for a rise.  A strong engulfing candlestick pattern emerged soon after and it was time to buy.  I bought at ~3.99. My target was 20 points and looking at the strength I felt that it would rise and try to retest the morning high of 4.15 and go further.  I was wrong.

 

It rose all the way upto 4.10 and stalled.  Look at the deliberation in the stock after it reached 4.10. It could not break out from there.  One look at the daily chart would tell you why.

 

The stock has been trending down in a channel for the last few months and the morning high of 4.15 marked the top of the channel and it was time for the stock to retreat.  Yes, I should have seen it coming before, but the trade based on the 5-min chart was a good one nevertheless.  It had a strong upward momentum albeit the price target was too optimistic on my part.  After seeing the daily pattern it was time for me to fold.  Not only that, I had to go short because the channel pattern was very compelling and the stock showed all signs of retreating.  So I shorted near 4.09 moments before it rapidly declined 4-5 points. The stock closed near that mark and I left the position open overnight. 

The stock opened lower and was sitting near 3.95.  I hoped to close my position near 3.85 near which the 50 MA  should provide support.  I was wrong again.

 

The stock was stuck for a long time below 3.95.  Then suddenly it shot up with a marubozu (a candlestick with no shadow - it signifies strength) on the 5-min chart and then remained above 3.95 (red circle).  So far the stock was behaving according to my expectation.  But this strong move above 3.95  forced me to review my hypothesis.  The stock could go either way crawling its way back to 4 or breaking down eventually.  But I decided not to take the risk and closed my position.  But it looks like I was 'wrong' one more time. It headed downwards eventually.

So you see, in spite of being wrong a number of times and changing my perspective repeatedly, I managed to make money, 10 points on the long side and 15 points on the short.  And that is what matters at the end of the day.  

In this post, I have implicitly and intentionally introduced many little things (channels, candlestick patterns, trendlines, price action), none of which I have explained in any detail.  These form the backbone of my trading and I will devote multiple posts in the future discussing their nuances. I will show why these are powerful and why you need to master them.  Till soon, keep it simple.

 

Disclaimer:  This post is for educational purposes only and I am not issuing buy/sell recommendation on any stock.  Please do your own due dilligence before trading securities of any kind.  

Trading secrets: What makes a good trade?

I will give you three options:  1) Being right  2) Making money and 3) Making the right decision even if that means you lose money.  I hope most of you answered with either No.2 or 3 because if you answered with No.1 then you are in for trouble.  Serious trouble.  There can be nothing more wrong than trying to be right about the direction the market (or your stock) is going to take.  Yes, thats true and no I am still on my second.  Read that sentence in yellow again and note the 4 words in red.  That is the root of your problem.  You need to keep in mind one thing.  If God came and sat beside you one day and said "Son, I know which way that stock is headed", you should politely ask him not to disturb you again. That is because don't let anybody tell you they have the slightest idea of what is going on.  No one does and we are all blind monkeys in a dark room trying to figure out where the light switch is.  No one has any clue but the smarter one will know that it should be in either of the four directions and next to the door. So he might try to find a big hole on the wall first.  But even then he has no clue about which direction he needs to go to find the switch or that hole for that matter.  If he is smart he will test out all directions one at a time, immediately retracting if his hunch was proved wrong and then try another direction.  His objective is not to find the switch in the first try but to find it eventually.  And so should be yours, because trying to be right is detrimental in the long run.  Instead, take your time and be ready to admit when you are wrong.

The best traders are those who react to market conditions and hold no opinion whatsoever about the direction of the market.  He sees the market as a wave and he is good not because he knows how high the next wave will be but because he knows how to ride it - come what may.  In this regard he is like the surfer whose only equipment is a 5-ft long piece of wood and the rest of it is his skill.  He doesn't brace himself up with anything else.  Out in the ocean its him, the wood and the waves.  And very similar are the workings of the very best traders.  They are not good because they were right about the market conditions more often than the rest.  Over time you will gather some qualities which will give you a better foresight, like the monkey knowing the switch should be by the door, but that is just a fraction of the story.  Most of the time our ace trader might have been wrong but he knew exactly when to call it quits instead of letting his ego come in the way and saying, " This cannot be true.  All the indicators were pointing in the other direction.  So why not wait for some more time and let the stock correct itself".  Chances are, it never will.  

Always remember that at the end of the day it is about making money.  So those of you who chose No.2 got it right - but only partially.  And why is that?  Because you could have just gotten lucky. This can prove to be fatal if a beginner gets lucky a few times.  You can write it down that he is going to lose it all.  I know because I have been there. Twice.  But nonetheless, it is a good way to measure your success.  At the end of the day it should always be about your account balance; not the half-hour period where you correctly predicted the market direction  (but were too timid to bet on it ), not the number of times your chosen indicators marked sell and the market or the stock tanked right after (you were in the loo so could not take full advantage of your state-of-the-art system) or even the one time when you did everything right but could not call off the cosy relationship you were having with the stock, at the right moment (thereby giving away most of the gains).  It should be about how much money you made that day and nothing else. Period.  But even then it should not be gamble money. In that case you have failed as a trader.

That brings us to those who answered with No.3. Good job.  Many a times I have found joy in losing money.  No, I am serious.  You will know the feeling when you see the stock tank right after you sold out of your position and got away with a couple of hundreds in losses.  But those are the rare moments of glory.  Most of the time you will see the stock make a whipsaw and go in the direction you wanted it to go, but only after you have sold your stake.  Watching that takes might, I tell you - to take a loss from a potential winner which actually won the race, but only after throwing you off her back.  Only after facing a lot of these will you become obdurate enough to not let them get in your way.  At the end of the day you should be able to tell yourself,  'I did the right thing' and NOT  'I was right'. That is what differentiates  good traders from bad. 

In the next article I will write about a trade I made today.  In that post you will see how being wrong isn't so bad after all.  

 

 

Chart patterns - the flipped check mark

This is by far one of the worst traps for a momentum trader. I call this the flipped check mark.  You see a stock going down for days and then suddenly it shoots up one day.  You buy on momentum only to see it end in the red.  The following days lead to more bleeding and you end up with a pattern that resembles a check mark, only flipped - long term price depreciation followed by a short spike.  You cannot help but shout, "Why do I fall for this every time"?  

Because you think the movie started with the short spike while in fact it began some time back. You are just watching  the end and not a happy one at that - not at least for the audience.

Let us take a step back and look at the daily pattern of the stock.  Usually these are stocks going downhill for quite some time.  Then one morning, BAM!! -  the stock blasts off on all cylinders.  The novice momentum trader,  eager to get in on the bandwagon, finds himself in a tricky situation after an hour.  The stock went up 10 points after buying but then gave back all of it and then some more. Now you are left with the dilemma; whether to get out or not.  If you can, you are wise.  Because rest of the day will only bring in more misery.  So what's going on?  Lets start by looking at the daily chart of such a pattern.

 

If you zoom out and look at such a chart you will find the following  characteristics:

1. The pattern has been repeated before with each high bleeding to new lows
2. The highs usually last for a day or two
3. The  highs are usually lower than the previous highs and
4. There is no news associated with the sudden rise and the message boards are rife with impending news (that never come)

Now folks, this is what is happening.

These stocks are usually beat up.  They are shorted to death by the market makers.  After the initial short position and as there are no buyers, the price usually goes down.  It drifts lower because of people selling small amounts over months or weeks.   Now the market makers need to cover their initial short position in this low volume stock.  So one day they suddenly start buying.  But these people are smart.  Instead of just covering their original short they use this situation to their advantage.  Their buying up builds up a suckers rally and some momentum buyers get caught up in the frenzy.  And this provides the fuel for the next short position. Once enough suckers have added position and after the market makers have covered their initial short positions they do what they do best - they short it again.  And the whole story gets repeated.  

Let's see what the 5-min chart of friday (the last trading day in the above chart) tells us.

 

The stock shot up in the morning session.  Then it couldn't move any higher and the price dwindled back to the lows because there weren't any real buying going on.  In the afternoon session the price shot up again.  This time the market makers could probably cover all their short positions.  Notice the big red candle with the high volume.  This is the sign that the next big short position is being built up.  Knowing that there is no real demand for the stock in the market the market makers can be sure that over the next few days  the stock will give back all its gains and head lower when they will rinse and repeat.

So how do momentum players insure themselves against such stocks?  It is not difficult.

Look at the daily pattern for at least a year before jumping in.  Chances are the rinse and repeat population have tried this before and on the same stock. The specialists usually target specific stocks and each stock has a typical character which reveals itself if you stare long enough.  If you see a flipped check mark in the daily chart then you should steer clear.  Another red flag is buying a rapidly-rising-on-high-volume stock which had previously drifted lower for several days.  The operative words here are 'drifted lower'.  It is OK if the stock was range bound for days and was breaking out. But it is NOT OK if the trend was down over the last few weeks/days.  You are better off not getting involved.  She will only cause you heartbreak and leave you with a hole in the pocket. Just not worth it. Trade safe.

Disclaimer:  This post is for educational purposes only and I am not issuing buy/sell recommendation on any stock.  Please do your own due dilligence before trading securities of any kind.