Let's Look At Two Trades From Yesterday

In talking with fellow traders, and reviewing my own trading sheets for the last several weeks, it became rather clear that the "Fade The Gap" trades are a large part of my recent trading income. Given that HVT remains subdued, these are the trades you need to be on the lookout for. I am going to review two trades that I took yesterday which met the criteria.

Amazon (AMZN | Quote | Chart | News | PowerRating). Yes, a Nasdaq stock. For the most part I do avoid them, but for a trade like this, I will trade them on occasion. Here is what I saw on the opening that got me interested in taking this trade.

1. The stock opened well outside the upper Bollinger Band.
   
2. The stock, in percentage terms, was up nearly 4%, whereas the S&Ps/Nasdaq were up only fractionally or flat. So on a relative basis, we have a "disconnect."
   
3. The opening low, $26.40, was breached....The Trigger.
   
4. Stochastics followed shortly after, as did a small sell-off in the futures.

Like all HVT trades, the trades are closed out when the momentum begins to slow. In this case, the 20-period EMA provided some support, and then when the bar (refer to chart) labeled Exit Bar exceeded the previous bar's high, that was evidence enough for me to exit. Yes, ultimately the stock continued to trade lower despite a strong market, but my game is not making grandiose predictions, it is taking and closing the trades that offer the highest probabilities. At the time, the stock was still up, on a percentage basis, a decent amount, why fight the immediate trend?

The second trade took place in Wyeth (WYE | Quote | Chart | News | PowerRating). Unfortunately, given that the stock did not open until 9:48 EST, the charts that I have plot out the opening indication, this makes the chart unclear for use in demonstrating the trade. Nonetheless, it followed the same rules as shown above.

1. Stock opened far above upper Bollinger Band.
   
2. Stock opened far above Tuesday's close, 13% in fact

I sold the stock short right on the opening trade. This trade was placed as a MARKET order prior to the opening. By virtue of the NYSE market, I knew the indication of the stock prior to the opening. This is what the opening indication looked like:

WYE 40 x 42

Tuesday's close was 35.86. So, we know in advance that the stock will open well above the upper Bollinger Band. What we do not know, and why I typically do not place the order prior to the opening, is...

"Will the opening price be the 'high' for the short-term?"

Many times these stocks gap up or down a large amount, but continue to move higher/lower before ultimately reversing very hard. So, it is a calculated risk. Do you fade the gap immediately, or wait to see how the stock reacts? Ninety percent of the time I will let the stock open, then make my decision based on price action. Yesterday, I just jumped in. The stock was opening up so much that it seemed very unlikely that the stock would run much higher.

I got my fill to short WYE on the opening price at 40.85. The market immediately looks like this:

40.80 x 40.85

The size of the bid and offer was:

20 x 90, which translates to 2,000 on the bid and 9,000 on the offer.

Suddenly though, the market changed:

40.85 x 41 with a bid offer of 100 x 5.

I thought I had been caught. However, no trades ever went off above the opening price of 40.85. In fact, after a minute or so, the market reverted back to:

40.80 x 40.85

At this point I knew I was golden. Over the next few minutes, several very large trades took place at lower levels. The drop was very orderly. Again, suddenly the downside momentum stopped, and one fairly large trade took place on an up-tick (offer), that was my cue to exit the trade. The trade was profitable. Yes, the stock traded a bit lower, but for the most part I caught the meat of the move. That is what HVT is all about, catching the meat in the middle, not trying to call exact reversal points.

As always, feel free to send me your comments and questions.

Dave