Ok, I know this is a little sick, but be honest: is there anything more fascinating in the financial markets than watching a previous high flier “crash and burn?”
Now it’s time for a ridiculously broad generalization (ridiculous except of course for the fact that it is true): There is a tendency for financial securities to decline in price far faster than they rise.
To put it another way: It is not at all uncommon for a stock or a commodity to rise steadily for an extended period of time and then suddenly end up giving back all - or at least large portions - of their gains in a small fraction of the time.
Which leads us directly to:
Jay’s Trading Maxim #101: Beware the trap door at the top of the escalator.
Or, if you prefer:
Jay’s Trading Maxim #102: What goes up runs the risk of coming down - really hard.
So the easier the ride and the more comfortable you become on the way up, the more – not less - fearful you should be of what may follow.
To illustrate let’s consider an example. In Figure 1 you see a weekly bar chart for Netflix (NFLX).
Figure 1 – Netflix (NFLX)
As you can see NFLX was a fantastically persistent growth investment – well, at least right up until the point when, well, it wasn’t anymore. Then it was more like an earthbound missile.
So the obvious question here is, “is there some way to profit from this?” Let’s take a look.
Jay’s LOB (“Look Out Below”) Method
Here are the things we will look for.
A) A stock that closes above its 30-week moving average at least 40 of the past 52 weeks.
B) The weekly 14-bar ADX exceeds 45 somewhere along the way during the advance.
See Figure 2
Figure 2 – Netflix advancing sharply
Then:
C) Eventually the stock registers a weekly close below its 30-week MA
D) The MACD Oscillator (18,37,9) < 0
Figure 3 – NFLX starts to break
Then:
E) Weekly 2-period RSI >=40
Then:
F) Sell short (or buy put option) the next time the daily low < previous weeks weekly low
Figure 4 – NFLX (RSI moves above 40 then price breaks below previous weekly low)
Then:
In many – though of course, not all – cases, Look Out Below!
Figure 5 – NFLX collapses
Some Other Examples
Figure 6 - AAPL
Figure 7 - CMG
Figure 8 - XEC
Summary
As with any setup, there will be times when with the “Look Out Below” Method when everything will seem to line up perfectly and yet the security in question will fail to plunge as expected.
So yes, as always:
1) There is no such thing as the “holy grail”.
2) A little bit of risk management is always in order.
Jay Kaeppel
Staff Writer and Trading Strategist
Optionetics.com ~ Your Options Education Site
