I've used the technique that follows a number of times in the past, and it really can pay off with some huge gains rather quickly and really isn't as risky as it may sound initially. The basic principle is to find a stock that has run like crazy, is way out of whack with its moving averages, and that is showing divergence on its RSI. Take Cirrus Logic, Inc. (CRUS). Last week Jim Cramer recommended it, and it shot up like a bat out of Hell. It gained about 35% in a week, and even with that, the RSI barely managed to break 70 because the prior peak was so agressive in the first place. I waited for the price to break the prior high. Once that rule was achieved, I waited for the RSI to break 70. At that point, I did the following:
- Put a short stop limit order on with the activation price the low of the prior day, which, when filled, activated
- A stop market order of the high of the prior day
When something is over 100% above its 200-day moving average and has already been in overbought territory only to get in there again and diverge, the euphoria is usually in. Everyone is blindly buying thinking that this is the new Yahoo! of 10 years ago. The stock is going to grind higher day after day after day indiscriminately and show sizable gains until a hiccup happens.
What you are trying to do here is not pick a top exactly, but rather to engage as early as possible in a pullback, which with a stock that behaves like this could be 20 or 30% in a matter of days! So when is it quite probable that the stock is going to break trend? Well, when a stock like this, that goes up 7 or 8% a day's intraday price breaks below the low of the previous day, all the euphoric margined up Coolaide drinkers are going to get spooked pretty quickly. To boot, there's a lot of attention on these stocks and the algorithms are programmed to retreat on the slightest smell of something afoul. The first waft of foulness will happen when the price breaks the low of the previous day.
So let's look at CRUS here. I happened to catch this one on the first day I put the stop limit order on. It gapped down at the open, and there was no turning back. Now the one thing you have to stomach is the risk here. Once I'm in the position, I have a basis of the gap between the price of entry for the position (in this case about $14.30) and the high from the previous day ($15.74). That's sizable (9%), and you have to be willing to risk it. You usually are OK to because as I said, 9 times out of 10, once people start seeing this stock breaking down like this after the run it's had, it's difficult for them to pony up and try to push it up higher.
Another tell for this stock was that a couple of days earlier, it had had the highest volume day in 3 years. That's a lot of buyers that burned through the stock. Really, who is left to buy? But this is an added benefit. It's not a requirement for me to get involved here.
So what do you do after you're in the position? Every night, you reset your stop loss order to be the high of the previous day. For example, tomorrow, my stop loss will be adjusted to $14.46. So the exact same price action that got you into the position gets you out, but in reverse.
You can do all of this on the long side, too. Just take everything I said above, and do it just the opposite. I'm up 3% on this in 2 days. Once this decline ends and the stock resumes its trend, which it will do (you can see by the declining volume on the two recent down days I've held it), hopefully my gain will be sizeable.
This is a side trade from my usual style. I did make my usual weekly trade. As I mentioned, I entered OWW this morning. No other trades this past week to speak of.
As usual, thanks for reading!
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