Against a Top With an Easy Stop

Considering the possibility that the prolonged rally in the overall market may be getting a little long in the tooth, we must look to sell strength in stocks when the opportunity presents itself. A big mover such as Facebook (FB) provides the perfect opportunity, especially with an easy stop, and backed up by a strong formation.

Examining the 5-minute FB chart from Tuesday, March 2nd, the short-term top it put in over the past few days at around 267 is clear to see. Corresponding with an afternoon rally in the major indices, FB traded up to 266; a $3 rise from the intraday low that it sold down to after the morning high of 266.71.

The Trade:

Taking three things into account: 1). the multi-day top in FB at 267; 2). that FB spent almost an hour hovering just below 266 after a mid-day rally without breaking above; and 3). a simultaneous hearty rally into resistance in the major indices, I sold short 700 shares of FB at 265.81, with a stop right above 266.

The Rationale:

I must admit that what is essentially a 20 cent stop, especially in a stock like FB, is a bit tight in most situations. Depending on the parameters for the trade, your trading strategy, and tolerance for risk, you can usually stand to let a stock such as FB slip 50 cents, $1, or even more when planning a stop. But given the formation, which included a wall of resistance less than $1 above the trade price, and which again also corresponded with similar formations in the general market, the quick stop was the prudent choice in this circumstance. I reasoned that a test of the highs at 267 might prove that a short-term top had NOT in fact been put in place, which could have resulted in a breakout through the highs; and I was not willing to risk more than $1 on the position late in the day. Besides, after basically hanging out in a holding pattern right below 266 for the better part of an hour, it was safe to assume that if FB broke above 266, that it was at least going to make a run for the recent highs. If I happened to have gotten stopped out right above 266 only to see FB still run out of gas below the 267 high, or even make a slightly higher high, I could always quickly put it out again with a similar such stop as before. Or, if FB did indeed break out above 267, and I was emboldened to do so, I could have bought the upside momentum, as break outs are often good for a few dollars. So, even if my original trade didn't work and I got stopped out, I likely would have options for quickly re-entering. 

Traders can very easily sabotage themselves with too quick of a stop because it may prevent a winning trade from developing properly. But, if you're paying attention to your markets, you can get away with a quick stop because the resulting loss was mild, thus leaving you solvent enough to swiftly and confidently get back into the trade if you feel you should still be involved.

The Result:

In this case, my read was correct! FB indeed did not break above 266, and in fact sold off more than $8 into the close, in sympathy with the overall market which also petered out and reversed at the end of the day as traders either took profits from their long positions or perhaps got short sensing that an overall reversal was in the cards.

For a risk of less than $200, the trade made more than $1,300, buying back shares along the way as FB rapidly dropped. 

The Takeaway:

You can make any trade you want to as long as you have a proper stop. Just keep in mind that not all stops are proper (even if in most situations, any stop is better than no stop), and that not all trades are created equal. As a technical trader, I find that the best trades pass the "formation test". A strong intraday formation is critical. But, when it's backed by a formation from days gone by, preferably from recently, and you have a reasonable stop, you more than likely will put yourself into a winning trade. While individual stocks are not necessarily reflections of the broader market, even the supposed needle-movers like FB, in this instance I was able to throw my read of the overall market into the mix for added confirmation. Learning to recognize strong formations and how to properly manage a stop will set you up to make profitable trades. Suffice to say, at least on a day trading basis, this trade at the end of the day in FB clearly fit the bill.




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