The Last Good Trade: Bank of America (BAC)
When the going gets tough, the tough sell high and buy low.
Bank of America
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PowerRating), in the news today because its announcement of $2 billion in write-downs and word that the company had a 77% decline in profits in the first quarter, is one of the weak stocks that traders who sell high and buy low have been able to take advantage of in recent weeks. What follows is the TradingMarkets Last Good Trade for Bank of America, an example of what our very simple approach to short term trading looks like in action.
Even though we did not take this trade, TradingMarkets Last Good Trade is an opportunity for traders interested in improving their trading success to see how our approach to swing trading might work for you.
We look to sell weak stocks showing temporary strength. What does this boil down to?
1. A stock that is trading below its 200-day moving average
2. A stock that is overbought
What do we mean by a weak stock? For us, a weak stock is a stock that, like Bank of America, is trading below its 200-day moving average. These are the stocks that, according to our research, are most likely to experience the sort of failed rallies that short term traders can take advantage of.
So, that what a weak stock is. But how do we know we have a stock that is overbought and showing the sort of temporary strength that traders can actually bet against?
We use the 2-period Relative Strength Index as one among many indicators that help us determine whether or not a stock is overbought. Any time a stock has a 2-period RSI above 90, we believe we are looking at an overbought stock. And when that overbought stock is also trading below its 200-day moving average, then there’s a good chance we have a stock we can wager against.
The Last Good Trade in Bank of America, which happened in the second half of March, fit this scenario to a T. The stock was trading below its 200-day moving average, clearly demonstrating its weakness.
In the second half of March, however, this weak stock appeared to get its groove back. From a low of $34.25, BAC rallied to more than $40 in three days.
In doing so, Bank of America’s 2-period RSI climbed above 90. Because BAC was still trading below its 200-day moving average, this was a warning sign-and an opportunity for traders willing to consider a bet against the stock.
The day BAC’s 2-period RSI climbed above 90, the stock closed at 41.80. Using our most basic and straightforward short term trading approach, all it would take was for this overbought stock to rally another 2% to trigger a short trade. We like a stock to show its hand as an overbought stock, and then to actually overplay its hand with some additional intraday strength.
This helps us take positions in stocks at the most advantageous levels in the stock. Our research has actually found that the more intraday strength we allow for–waiting for 4% or even 6% beyond the previous close-the better the results of the trade. While waiting for these higher numbers does reduce the number of overall trades, it is certainly a factor for traders to keep him mind, given the effect on deeper pullbacks and bigger bounces on trade returns.
In the case of Bank of America, 2% beyond 41.80 meant taking a short position at 42.64-a level the stock reached the very next day.
In at 42.64, how does a trader get out? We use a dynamic exit rather than a fixed percentage or number of points. We are comfortable taking what the market gives us. So here, a close below the 5-day moving average is our signal that it is time to take profits and look for the next opportunity.
That close below the 5-day moving average came three days later, with Bank of America closing at 39.84, some 2.8 points below our short entry. Traders exiting on the open of the following day would have still managed to take more than 2.6 points out of a three day trade.
Not every trader who uses our approach to trading will get 2-3 points in three days with every trade. But traders who follow our short term trading methods, either on their own or as a student in our 14-week Swing Trading College, will know that they are following trading techniques that have produced more than 70% winners in historical testing going back to 1995 for long trades and better than 60% winners in historical testing for trades to the short side.
Our next presentation on the TradingMarkets Swing Trading College will be at 4:30 p.m. Eastern on Tuesday, April 22. Larry Connors, CEO and founder of TradingMarkets.com, will host the presentation, during which he will give listeners a basic outline of the 14-part, online, swing trading course.
As a special bonus, Larry will share a new strategy that has just been developed especially for traders in exchange-traded funds. The “Double 7’s Strategy” has only three rules, but has performed very well in our historic testing from 1995 through this spring in the S&P 500 and Nasdaq 100, as well as in international ETFs such as the FXI
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PowerRating) (China) and EWZ
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PowerRating) (Brazil).
So be sure to register today for Larry Connor’s special teleconference on the opening of one of our most popular features, the TradingMarkets Swing Trading College. Click here to reserve your spot-or call us at 888-484-8220 today.
David Penn is Senior Editor of TradingMarkets.com