How To Play Failed
|Twisted logic can devise very profitable trading strategies.
For example, we're taught early in our careers to buy breakouts
and sell breakdowns. But market contrarians pay their bills
doing the exact opposite. They wait for a move to fail, and then
sell the breakout or buy the breakdown. These mind-bending
tactics don't end there. Many smart traders take it one step
further and buy when the failure fails.
||Let's back up and examine this way of thinking one step at a
time. Most of us follow a common path -- we pile into stocks
because they break out of resistance. But contrarians know
exactly how you'll react when your pretty breakout drops like a
rock. So they guess where your stops are hidden and enter short
sales at the same price to capitalize on your misfortune.
|Now twist your brain a little more and take this reasoning to
the next level. The stock breaks out -- you sit on your hands.
The stock fails the breakout -- you wait and do nothing. But
when the stock jumps back above the breakout price -- you buy.
Modern markets try to burn everyone before they launch definable
trends. My friend Bo Yoder calls this action a "rinse job."
Whether through manipulation or mechanics, price gets drawn like
a magnet through common support and resistance levels. This
whipsaw movement cleans out the stops before a market ramps
higher or lower. Not a pleasant experience when you're caught
holding the bag, but an excellent opportunity when you come off
How does price action "know" where the stops are hidden? The
answer is quite devious. Retail traders are well-versed in the
basics of technical analysis. They take positions using common
methods already deconstructed by the smart money. The result:
Price passes through support and resistance far more easily than
in the past. But keep your chin up. Whenever someone comes up
with a new way to take your money, they also give you a new way
to make it.
Let's look at failed failures on several stocks we've discussed
in recent weeks.
We made the case for a bounce play on Concord EFS (CEFT) on Dec.
10. Using the intersection of two key Fibonacci retracements, we
suggested Concord would reverse near $29 and start a run back
toward its high. But things didn't work out that way.
Four days later Concord gapped down through the entry target
and made a mad dash to the 50-day moving average. It tagged it
early in the session and reversed, closing back above $29. The
next morning, price gapped above the entry target and completed
an "abandoned baby," a significant one-bar reversal pattern.
Concord then rallied to test the old high.
Fortunately, the gap down should have kept swing traders on the
sidelines. Most effective trading strategies limit entries after
unusual gaps. But those already positioned had stops in the
middle of that rinse job because it looked like a safe level on
the price chart. There's a diabolical trading lesson here: Safe
prices are also the most dangerous ones. How twisted is that?
On Nov. 8, we looked at Oxford Health Plans (OHP:NYSE - news -
commentary - research - analysis) and made the following
prediction: "The intraday bars of the last two trading days draw
a bullish pattern that looks close to breaking out."
As someone else around this organization likes to say --
Wrong! Oxford Health decided to go in the opposite direction the
same day the column was published. Look at how the two-day rinse
job filled the gap, before price jumped back into the resistance
What happened next is even more interesting. Oxford spent a week
gathering into a tight little ball. In fact, the last bar before
the breakout printed a "NR7," the swing trader's term for the
narrowest range bar of the last seven bars. This quiet signal
often precedes major price expansion and is a telltale sign of a
market ready to move.