I have made my living as a professional trader for more than 15 years. During this time I have methodically developed a successful trading approach based upon a core set of commonsense (but often overlooked) market principles. One of the things I have sited over the years is many investors completely ignore shorter-term stock trading opportunities, particularly those offered by reactions within long-term trends. And these are some of the lowest-risk, highest-potential trading situations they could ever venture to find.
When stocks go up quickly, they will usually pullback for 3 to 10 days when profit-takers lock in their gains. And then after this resting period is over, such stocks will many times continue their up trends. I have learned that one of the best ways to trade stocks is to identify strongly trending companies that have pulled back and are poised to resume their longer-term move.
One of my favorite methods of capitalizing on the tendency of trending markets to pull back is called "l-2-3-4s" because the setup takes four days to complete. Days 1, 2, and 3 form a countertrend move in a strongly trending market. Day 4 is when you enter your trade. I like to climb aboard these stocks as the move begins, and I stay with them for as short as a few hours to as long as a few days.
Here are the rules for this short term trade. First, you want to identify a strongly trending stock. This can be done by using the Relative Strength rankings on the TradingMarkets.com site or in Investors Business Daily. Ideally, you want to trade stocks with RS rankings of 95 or above. Secondly, you wait for the stock to make a three-day pullback, especially following a short-term high. This means that after making a short-term high, the stock makes three consecutive lower lows, or a combination of lower lows and inside days. (Inside days are days for which the high is less than or equal to the previous day's high and the low is greater than or equal to the previous day's low).
As I've noted, three-day pullbacks are a common phenomena in strongly trending stocks. The important question is, how should you enter the market in these situations? For up-trending markets, enter a long position on Day 4, 0.10-0.20 above the Day-3 high.
Right after entering a position, I protect myself with a stop right under the Day-3 low. For example, if the Day-3 high were to be 42.25 and the low is 41 .50, then I would buy the stock on Day 4 at 42.35 to 42.45 and place a good-till-canceled (GTC) stop order right under 41.50. This is what I do to help minimize my losses if the position goes against me. Pullbacks offer great trading opportunities, but if you don't use proper risk control, the best entry technique in the world won't do you any good.
Another great aspect of l-2-3-4s is they are great for shorting the stock market"which is something all successful traders need to know how to do. From 1982 through 1998 the stock market went up a most of the time, giving birth to a generation of "buy only" equity traders and investors conditioned so believing this was the way the market worked and always would. Unfortunately, while many of these long-side-only traders may have profited during this unusually long bull market, they will get decimated in a bear market. This is not a prediction, it is a fact.
I have found out firsthand that you have to have strategies that are profitable in falling markets as well as rising ones if you want to trade stocks profitably in the long term. This means you have to learn to short stocks. For instance, you can also l-2-3-4s and other pullback strategies with weak strong stocks. You simply invert this concept to short weak stocks. All you do is identify imploding (declining) stocks and wait for them to rally a few days. When they begin to resume their longer-term downtrend, they become solid short-selling candidates.
When stocks go up quickly, they will usually pullback for 3 to 10 days when profit-takers lock in their gains. And then after this resting period is over, such stocks will many times continue their up trends. I have learned that one of the best ways to trade stocks is to identify strongly trending companies that have pulled back and are poised to resume their longer-term move.
One of my favorite methods of capitalizing on the tendency of trending markets to pull back is called "l-2-3-4s" because the setup takes four days to complete. Days 1, 2, and 3 form a countertrend move in a strongly trending market. Day 4 is when you enter your trade. I like to climb aboard these stocks as the move begins, and I stay with them for as short as a few hours to as long as a few days.
Here are the rules for this short term trade. First, you want to identify a strongly trending stock. This can be done by using the Relative Strength rankings on the TradingMarkets.com site or in Investors Business Daily. Ideally, you want to trade stocks with RS rankings of 95 or above. Secondly, you wait for the stock to make a three-day pullback, especially following a short-term high. This means that after making a short-term high, the stock makes three consecutive lower lows, or a combination of lower lows and inside days. (Inside days are days for which the high is less than or equal to the previous day's high and the low is greater than or equal to the previous day's low).
As I've noted, three-day pullbacks are a common phenomena in strongly trending stocks. The important question is, how should you enter the market in these situations? For up-trending markets, enter a long position on Day 4, 0.10-0.20 above the Day-3 high.
Right after entering a position, I protect myself with a stop right under the Day-3 low. For example, if the Day-3 high were to be 42.25 and the low is 41 .50, then I would buy the stock on Day 4 at 42.35 to 42.45 and place a good-till-canceled (GTC) stop order right under 41.50. This is what I do to help minimize my losses if the position goes against me. Pullbacks offer great trading opportunities, but if you don't use proper risk control, the best entry technique in the world won't do you any good.
Another great aspect of l-2-3-4s is they are great for shorting the stock market"which is something all successful traders need to know how to do. From 1982 through 1998 the stock market went up a most of the time, giving birth to a generation of "buy only" equity traders and investors conditioned so believing this was the way the market worked and always would. Unfortunately, while many of these long-side-only traders may have profited during this unusually long bull market, they will get decimated in a bear market. This is not a prediction, it is a fact.
I have found out firsthand that you have to have strategies that are profitable in falling markets as well as rising ones if you want to trade stocks profitably in the long term. This means you have to learn to short stocks. For instance, you can also l-2-3-4s and other pullback strategies with weak strong stocks. You simply invert this concept to short weak stocks. All you do is identify imploding (declining) stocks and wait for them to rally a few days. When they begin to resume their longer-term downtrend, they become solid short-selling candidates.
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