More Strategies for Entering Trades in High PowerRatings Stocks
In my last PowerRatings column, I talked about the way that short term traders using our stock rating system, PowerRatings, can use limit orders to take advantage of intraday weakness after a high PowerRating stock has pulled back. Click here to read my last PowerRatings column, “Take It to the Limit: How to Buy High PowerRatings Stocks.”
Specifically, our research has revealed that buying high PowerRatings stocks using limit orders anywhere from 2% to 7% below the previous close is a way of capturing some of the biggest edges when it comes to short term mean reversion trading in stocks.
The question remains: which is better, a 2% limit order or a 7% limit order?
The final decision here rests, of course, with the individual trader. But here are a few rules of thumb.
Trading with a 2% limit order below the previous close will likely result in a greater number of trades compared to trading with a 7% limit order. This is because by the time a stock earns a high PowerRating of 8, 9 or 10, the stock likely has already pulled back significantly. The odds of the stock pulling back an additional 2% are greater than the stock pulling back by another 7%. This means that the 2% limit order will be filled more frequently than the 7% limit order.
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On the other hand, our research shows that although a limit order closer to the 7% level will result in fewer trades, those trades will tend to be more profitable than with limit orders that are nearer to 2% below the previous close. Why? Because by waiting for a stock to pull back on an intraday basis by 5, 6 or 7% after it has already corrected means that the trader is looking at a very, very oversold market. And if there is one thing that is clear in our research on mean reversion in stocks, it is this: the greater the stretch, the greater the snap back. This has been borne out in the performance statistics for high PowerRatings stock traded with 7% limit orders compared to those with 2 or 3% limit orders.
For more information on this research, read Larry Connors’ PowerRatings primer, PowerRatings Does It Again – Results for 2008.
Here’s another rule of thumb: when looking at stocks with PowerRatings of 8, consider using larger limit orders to enter positions below the close. This will allow the stock to continue correcting and potentially give you a better and lower entry price. If the stock has a PowerRating of 9 or 10, then a tighter limit order of less than 5% may be enough to allow you to buy shares from the final desperate sellers just before the stock reverses and resumes its advance.
David Penn is Editor in Chief at TradingMarkets.com.