Picking the title for this lesson was difficult. This is a very advanced lesson that cannot possibly be totally conveyed to the reader by simply reading along. Your brain will ‘allow’ various amounts of information in, depending on your experience level. This lesson involves an ‘open thought process’, looking at every aspect of a trade from the ‘top down’ analysis, to managing the trade on multiple time frames, to using the add and reduce concept, and taking multiple targets and using various re entries, as the trend allows.

1. The first step in this process is to look at the strategy involved. We need to look at the big picture. Many of the most profitable concepts in trading do not come from the minutia of technical analysis. They come from knowing common patterns and how they play out. We use support, resistance, retracements, moving averages, specific bar formations and various other concepts to fine tune the major strategy. For example, the play we are going to look at is the gap over daily base that occurred in Constellation Energy Group (CEG). This was an actual play (a series of plays more accurately) that was done in the VCM Proprietary Trading Room. Below is the chart.

   

   This stock gapped over a long time daily base, clearing all resistance from the base. Playing ‘bases’ is probably one of the most common plays, and touted as an easy one. If you play them, you know they are not easy. Most breakouts actually fail, the way most traders play them. The secret here is to know the big picture concept. For this play, it is to know that the gap will usually pull in before it goes higher. A base this long is loaded with traders who are both long and short. On the gap, there are longs taking profits, and shorts that are covering. There are new traders getting long, and new traders getting short. One cannot predict whether the bulls or bears will be in power when the stock opens.

   The clue that gives us odds on this base is the fact that this is a very bearish pattern overall. While the stock may have been ‘over sold’, it dropped very quick and consolidated near the lows. There are many traders who are long that are trapped inside this stock that are sick of being there and are anxious to sell on a quick move up. This stock gapped up five points that morning. This gave traders a reason to sell. More important, forget the rationale. If you study these, you will find that gap ups out of bearish bases are usually sold. Now, since this was going to be a day trade, we are only interested in what this stock will do on that one day. Over the next several days, it is quite possible the selling will stop and the stock will follow through and go higher. However, we do not care. Whether the stock sells off for the next two weeks, or just one day, there are high odds that the day of the gap will be bearish. That is the strategy; to short the gap out of a bearish base.

2. The next step is to find an entry. One option is to just short the open as soon as the stock starts moving down. This works sometimes, and can be used on the best of the gap plays. This is not one of the best gap plays however. While we liked the idea of this stock moving down, it is hard to say if it will do it at open, or after five minutes, or after 30 minutes. This can lead to several stop outs before getting the trade right. So we want confirmation. We can short a five minute low, with a stop over the five minute high. That helps the odds. However it can still stop, and as you can see by the five minute chart below, the five minute bar was also huge (1) forming a bearish wide range bar, making for very wide stop.

   

   The wide bar often gets a strong countermove immediately following. So we wait for an entry in the form of a VCM sell set up or consolidation break down. We also want information that the bears are in control. We get that at ‘1’. The first counter rally attempt at ‘1’ becomes immediately reversed. As a matter of fact, if a sell set up forms in this area, it is often a good entry. The problem here was that the reversal came so fast there was no entry, not even on the one minute chart (shown below). However, after the event at ‘1’, we get a base forming just off the low of the red bar at ‘1’. This is both confirmation of weakness and makes for our entry. Everything inside the circle at ‘2’ is expanded and discussed in detail on the one minute chart, below. The entire process of the exact entry, and the addition of more shares are discussed on a zoomed down level on the one minute chart.

   

3. The entry and adding shares on additional confirmation comes next. As we are getting ready to enter, we come down to the one minute chart and get more detail. The decision has been made to enter, and we are fine tuning the stop and entry.

   We cannot enter at ‘1’. At the moment it formed, it was bullish. It was the failure of this move to go higher that confirms our decision to short. It is the base that forms going into ‘2’ that we want. It is a tight base, and the stock has proven its weakness. As soon as the first red bar at ‘2’ drops below the lows of the last five bars of the base, we short. The stop is over the top of the base at ‘2’.

4. Now the management process starts. We know this trade has the ability to drop all day, so we want the impossible. We want to protect gains as we go, add shares when we can without risking more money, and get to a big target. Traders are initially taught to take one entry, use one stop, and look for one or two targets. This works, but as traders progress, they usually work a good trade for more money. The most professional of all traders are actually buying and selling at multiple levels. The biggest and most professional traders are market maker and specialists, who make most of their money by bidding and offering on both sides of the stock price on a continuous basis.

5. The tight stop that was afforded at our entry at ‘2’ gives us a large share size. So we look to cover a good portion of the short as the red bars narrow and begin to reverse, at ‘3’. The rest of the position sits with the original stop at ‘2’.

6. The stock bases out under ‘2’ and has another break down at ‘4’. This gives us the same opportunity. This could be a new play, but since we already have shares we will be ‘adding’ shares, and ‘reducing the stop to ‘4’ all at the same time. We can add enough shares to ‘re-risk’ the original amount of money (which would give huge share size, since we are well in the money at this level) or we can add enough shares to bring the whole position to break even, or to a fixed gain. That is up to the money management of the trader.

7. Now, the same process repeats itself. The larger share size position drops hard to ‘5’, and a narrow bar forms. We cover some (half or more) of the position, as we trade over the narrow bar, and the rest of the position stays on board with the new stop at ‘4’.

8. Again, another breakdown at ‘6’, and the chance to add shares again (as explained in step 6) and reduce the stop to ‘6’ on the chart above. As the stock drops, again we cover some (2/3 to 3/4) and the process continues.

9. Note that the more the stock drops, the closer the trade will come to ending, so the more you cover on every decline toward the end. Note, how we start off covering ‘some’, then move up to ‘half’, and then to ‘more than half’. Note also, that we increase share size and profits without ever increasing risk. While this trade would have worked well by just taking an initial share size and holding, this method described has two advantages. First, it accelerates the gains by adding at key moments and increasing share size. Second, it keeps the trader safer and with profits locked in. The problem many traders have is taking this trade from ‘2’, all the way to ‘7’ or more, as they normally get out too soon.

10. While this method can be very profitable, it must be learned like any concept. Start off learning how to trade simple trades with basic money management, but use this as a guide to use to develop your money management skills.

The bottom line is that all the strategies can be learned; but money management is what makes for successful traders.