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Kaeppels Corner: The Look Out Below Method

By Jay Kaeppel, Optionetics.com | Wed December 12, 2012 2:26PM PT

 

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

 


Recent articles by Jay Kaeppel, Optionetics.com


July 24, 2013  -  Kaeppel's Corner: Just When You Think You Know It All....
July 15, 2013  -  Kaeppel's Corner: Beware the Market BLIP (Bernanke Linguistics Induced Panic)
July 09, 2013  -  Kaeppel's Corner: Words to Trade By
July 02, 2013  -  Kaeppel's Corner: Of Gold Stocks, Falling Safes, and Moths to Flames
June 24, 2013  -  Kaeppel's Corner: How To Enjoy Market Summer Boredom


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