How’s that for a confusing, convoluted title… hopefully this post will make more sense!

Much of the discussion here has revolved around price and volume action on a daily or weekly basis, but what about when it comes to actually pulling the trigger on a buy or sell.  In other words, what are some of the things to look for on an intraday chart (I use the 5 minute) that will help us to achieve the greatest probability of success.  I say "probability of success" because nothing is certain right?  First of all, there are certain pit falls to absolutely avoid which over time will improve your results dramatically.  It’s actually quite simple.  AVOID TRADING in the first 30 minutes to an hour of the market open (of course there are exceptions which I’ll get into in  a bit – it wouldn’t be a rule without an exception!).  Why?  The first moments of the trading day are the most volatile and ruled by news events, amateur and/or retail trading, overnight orders and market maker manipulation.  With few shares traded at the open, it’s easy for a stock to swing wildly up or down at the open resulting in a gap up or down. 

Rule to trade by: Don’t buy or cover a gap up and don’t sell or short a gap down at the open (first 30 – 60 minutes of trading).  An exception to this rule would be a major news event announced.  If a company announces a formal SEC investigation is taking place, it is probably not in your best interest to ride it out for the first half hour.  You’ll most likely want to cut losses or lock in gains as quickly as possible… then go find the Tums and the aspirin.  Now, it’s important to point out that the opposite of the rule above can be applied to lock in profits or to initiate a new position.  For example, let’s say you’ve purchased a stock and the technicals are telling you it might be a good time to lock in profits.  Maybe the stock has reached an upper trend line and you’re already sitting on a 30% gain.  If the stock gaps up at the the open with a significant move, I’ll lock in profits in the first minutes of trading.  Conversely, if holding a short position and the stock gaps down to a major support area, it might offer a great chance to get out with nice profit at the open.  Using the opposite of the above rule to initiate a new position (ie. shorting on a gap up and/or buying on a gap down) should be used sparingly and with much caution.  A scenario where shorting on a gap up might be useful is if a stock has been hit with institutional selling and has plummeted below major support.  The selling subsides momentarily and the stock works its way back to that support area (which now acts as resistance).  One day the stock gaps up following some good news from a competitor, but hits resistance and retreats immediately.  It may offer a good chance at a short.  Very rarely, if ever, is it a good idea to make a long purchase on a gap down even if the stock bounces off support.  It’s much more of a gamble.

If you’re new to this stuff, reading it might make little sense.  This kind of discussion is best illustrated through the use of annotated charts (thankyou StockCharts.com for great charts!).  I’ll begin posting more intraday charts and lessons here at the blog to better illustrate these points.  For now let’s take a look at OMI Corp (OMM) which illustrates the bolded rule above well.  Below is the daily chart which represents trading up to the end of the trading day on February 14th.  This is a great looking base with nice price and volume action in the right side and declining sell volume in the handle.  It was a bit quick to form in the right side, but hey, no base is perfect.  This is certainly a stock that should have been on many watchlists for a possible breakout.

The following morning, the company announced earnings and beat Wall St. estimates.  The stock gapped up at the open on the news quickly rising to $20  a share.  Yes, the stock soared past the pivot and NO, you should not have jumped in at the point.  (Remember: don’t buy the gap up at the open even if the stock blows past its pivot point.)  Almost immediately, the stock reversed course on heavy volume and closed below the low point of the gap up within minutes.  Taking a look at the first half hour on the intraday chart of OMM below, you see that the stock peaked at 20.09 and reached a low of 19.50 in the first half hour.  These are the support and resistance areas you are concerned with on an intraday chart.  If the stock clearly finds support at the low point of the first half hour with declining sell volume, there is a good chance the breakout will hold (of course you’d want to confirm that by waiting for price and volume to begin to spike higher – i’ll have an example of this later).  In the case of OMM below, the breakout clearly failed at 11AM EST as the stock plummeted below the low of the first half hour with heavy volume, confirming that the gap up has failed.  This is not a breakout that should have been purchased. (click for larger image)

Let’s assume you had purchased the stock at the the open and held throughout the day.  Your hope has turned to frustration, but you’re still in the stock with less than an 8% loss.  What to do?  First of all, you want to remember the first half hour rule of no selling on a gap down in the first 30 minutes (unless of course the company has come out with catostrophic news and/or you’ve hit your max loss allowed level – I use 10% as an absolute max on the loss i’m willing to take, but my average loss is around 6%).  Next, you’d want to map out your exit strategy if the stock continues to slide.  You’ll want to look at the daily chart and ask yourself these questions:  Where on the chart is a 10% loss on my purchase? Where is the next possible support area? Take another look at the daily chart of OMM below. 

Clearly, the stock has massive downward momentum at its back (based on the magnitude of the reversal in terms of price and volume).  It should come as no surpise that the stock would most likely continue that downward momentum (at least according to Sir Isaac Newton..) in the first moments of trading the next day.  So, looking at the daily chart, how much room would you give the stock to run?  I have highlighted the area around 18 as an area I would be willing to let the stock run to if I were holding the position.  Why?  For one, whole numbers often serve as support and resistance .. and two, because the 20 day moving average is near by at 17.80 (the 20, 35, 50 and 200 day moving average are closely watched by many traders – the 50 and 200 being the most important).  Not to mention, that is where my max loss of 10% might kick in.  OK, so we’ve taken a look at the daily chart and we now have a game plan for the next day.  A plan keeps emotions of fear and greed from affecting your trading decisions.  Stick to it.  So let’s take a look at the intraday chart once again and see how the trade played out the following day. (click for larger image)

As expected, the stock continued its downward momentum the next morning right at the open.  It would have been difficult to watch the stock continue its slide at the open.  Fear may have set in at this point, but you’re holding firm and watching the support level you laid out yesterday.  You’re going to avoid selling in the first half hour as long as you haven’t accrued a 10% loss… The stock hits 18 and the selling subsides, giving way to a bounce.  On the intraday chart, notice that the second 5 min price bar is a reversal.  Reversals often indicate bottoms.. whether that be on a monthly, weekly, daily or intraday chart.  In fact all rules apply no matter what time frame you’re looking at (ie. support/resistance and price/volume movement).  Ok, so the bottom of that reversal is 18 and that does end up being the low point of the first half hour.  So, that is your support line.  If the stock drops below 18, that is your cue to exit the position.  However, the stock showed some resiliency by bouncing and never looking back.  Notice the high point of the first half hour is 18.50, which would be your intraday resistance level.  The stock manages to get above this area indicating decent strength (although buy volume is lacking) and you’re still holding the stock awaiting the next breakout attempt!  Which brings up another important tip: don’t ever give up on a stock if it fails the first breakout attempt.  If you had bought this stock at the top the morning of the 15th and then sold for a loss, it’s natural to be disgusted with the stock and forever erase the memory from mind.  But this is a mistake.  Some of the most powerful rallies fail once or twice before exploding to nice gains.  The daily chart below shows OMM as of the close today (Friday, the 18th).  With the failed breakout comes a new pivot point to watch.  Look for a break above 20.09 with heavy volume as a buying opportunity. .. and remember, no trading in the first half hour!

The previous discussion of OMM details an example of a gap up failing.  Let’s take a look at an example of a successful gap up breakout.  The stock highlighed below is Metal Management Inc. (MTLM) which was purchased for the SelfInvestors.com Model Portfolio yesterday.

You can see the gap up breakout with very heavy volume as institutions continue to clamor for the stock and steel stocks in general.  Let’s turn to an intraday 5 minute chart to get a closer look at the gap up breakout. (click for larger image)

Notice how the stock quickly gaps up past the pivot point (highlighted in orange).  But you’re not buying because you know better… right?  In this particular chart, you needed to give the stock an hour to give you a firm intraday support area.  In this case, it was the bottom of the gap up at 28.75.  After the wild volatility of the first 30 – 60 minutes, the trading quiets.  You’ll notice the selling volume begins to decrease and the price hovers around 29 for an hour or so.  Given the strength in steel stocks of late and the magnitude of buy volume over the past few weeks I can be reasonably assured that the breakout will be successful.  What I’m looking for at this point is a break out of this quiet consolidation as an opportunity to pull the trigger on a buy.  Some traders will wait until the stock clears the high of the gap up, the "intraday resistance" before entering a position.  In cases like this, where you have a leading stock in a hot industry, I’ll give the stock the benefit of the doubt and purchase at the first sign the breakout will be successful.  For me, that signal occurred at 29.30 as the stock made another move up with increasing buy volume.  Remember that bullish patterns in daily charts can apply to an intraday chart.  Notice the step pattern of quiet consolidation followed by a small surge in price all the way up through the high of the first hour of trade.  So far the breakout looks great.  The next level of resistance to watch is right around 30.  As mentioned before, major whole numbers such as 20, 25, 30, etc. serve as areas of resistance.  I would expect the stock to consolidate for a bit around the 30 level before resuming its advance.

There are quite a few details here that may be overwhelming, especially if you’re new to investing and/or technical analysis.  I’d be happy to answer any questions you may have.  Just drop me a line at support@selfinvestors.com.