I figured I’d do something a little different here since I had some free time during the day. I'd like to give everyone a peek into my thought process on some of the stocks I’m trading. One of my favorite setups to play is a parabolic bounce where the stock has been beaten down a lot over a period of several days and then has a strong bounce which you can hold for a couple days as the early shorts take their profits from way above.
My most recent parabolic bounce trade was in REN. It’s actually a relatively simple play and easy to scan for since all you have to do is look for something that’s been red for 6-10 days in a row and has dropped more than 40-50% over that time period. Ideally it will be sitting on support on the daily chart like REN was, and even better if it’s a round number (e.g. anything ending in .50 or .00).
The idea is basically that stocks don’t go straight down. They ebb and flow with the trends in the market, and so when a stock becomes too stretched it will snap back like a rubberband. The further it goes down with no rest, the more violent the snapback. It should be noted that you want something that has had a series of selling days, not just something that has been hit hard with bad news. You don’t want to try to “guess” the bottom or catch a falling knife. If you do try to do this, you will be wrong and take a loss 99% of the time. Instead, you’re looking for a stock that is being sold constantly for several days with little to no rest so the sellers just exhaust themselves and over time it shows up on lots of traders’ radar.
Once a stock meets my criteria for a parabolic bounce (7 days down, greater than 40% drop, and minimum 500k shares average daily volume), there are a few indications I look for that a bounce is coming which allow me to time them reasonably well:
- First, you want to see the selling slow down. Look for the daily volume fade off and for the rate at which the stock is dropping to slow). This is where the early buyers will jump in and try to catch the knife. It’s also usually where you will end up being wrong if you buy.
- Once you see the buying slow down you want to see a couple last minute dumps as the final sellers dump their positions, kick the early buyers’ stop losses, and smart money starts filling their buy orders
- Over the next day or so you will start to see the stock show morning strength (rapid acceleration in the mornings accompanied by lots of volume). Once the stock shows morning buying strength you want to see it base above the major support. Also you will often see the stock close green on these days.
- The next day is the buy. Again, you're looking for morning strength followed by a higher base than the previous day. Now you can buy any time and hold for the swing trade with a stop loss under the major daily support or under the lower base.
Here’s an annotated chart for REN, showing my thought process and an example:
Subsequently, REN has had a 25% bounce today. I sold half for a 15% gain so far and will hold the rest for the next couple days.
A couple other notes: These work best when the market is also in a bounce area, so look for areas where SPY can bounce, and also focus on the type of stock you’re trading the bounce on and make sure its associated ETF can also bounce. In this case REN is an energy stock so I timed it with a bounce on SPY and also XLE (energy ETF). If you are trading a biotech stock, time it with a bounce in IBB, a consumer staple with XLP, etc. This way you have not only the dip buyers on the stock itself, but also dip buyers in the stock’s sector and in the overall market.
I hope this helps provide some insight into my thought process and strategy.
Until next time, happy trading!