Episodic Pivot #1
Buying Gaps does not have to be intimidating
Introduction
Often times, gap-ups can come across as intimidating and too risky to the average trader. While it is understandable and natural not to want to buy a stock that has already made a decent move and is up quite a bit on the day, this lack of confidence stems from a lack of knowledge and effort in mastering a setup.
Putting in the work and studying which kind of setups work under certain conditions allows us to improve our odds and get involved at a potentially pivotal point, while managing risk against a statistically proven area of importance.
Episodic pivot is a setup that allows you to identify these high-potential moves that start with a gap in price - popularized and traded by Pradeep Bonde (stockbee) and Kristjan Kullamägi (qullamaggie), these are times throughout the stock’s trading history where news catches investors off guard - this surprise is what leads to a big move as new information becomes available and forces investors to re-evaluate the stock’s potential.
This new information may change the trajectory of the stock, it is imperative to analyze the quality of that news and how significant it really is for the company’s future prospects. That is not to say that stocks cannot make impressive moves on lackluster news, however especially in institutional quality stocks - you want to look for strong news that generates more institutional interest, this additional interest leads to stronger buying and that could lead to a strong uptrend lasting several weeks, months or even years.
This is why combining technicals with fundamentals provides an excellent edge, being able to identify which stocks could generate an overwhelming amount of institutional interest - which later shows up in the volume - helps narrow your focus onto these high potential setups. Looking for liquid names with consistent earnings and revenue growth can help you focus on the best names available.
Amongst others, the new information / catalyst may be related to:
Earnings Beat & Raise
Sector Momentum
Regulatory Changes
Biotech Data
Significant New Contract / Customer / Order
Panic / Hype
It is very difficult for some of these massive institutions to hide their hand when there is a game-changing catalyst generating significant interest. If this is a real move it will show up in the volume. Volume is the 2nd most important data point after price, and can help provide a confirmation to that price movement.
I love to look for moves that are on track to finish the session on their highest volume ever or in over a year - a concept popularized by TraderLion - or even just significantly above average - ideally >x10 average daily volume.
Now, any stock can gap-up and go on to make a move - the key part of this is in avoiding random movements and buying every move in every stock. As always, it is essential to be selective and patient! Focus on opportunities that provide sound and low-risk entries, while accepting the fact that it is okay to pass on those that do not provide such entries.
Opening Range Highs
These stocks have a tendency to be quite volatile near the open, what you must focus on is being patient and not just buying randomly.
A core concept of buying these setups includes buying the opening range highs - meaning that you buy the break above the intraday high, typically using the low of the day as your stop loss.
Now this could be the opening range high of any time frame - 1min / 5 min / 15 min / 60 min etc. What you opt for depends on your strategy, timeframe and own conclusions drawn from your own research. You cannot borrow conviction from anyone else but must gain it from your own study.
The shorter timeframes typically allow you to get involved at lower prices, however, these usually have higher failure rates.
Let’s dive into some examples:
AAOI 0.00%↑ 12 January 2017
Gaps up in response to strong earnings (see chart)
Key here is that it is breaking out and gapping above this massive 3-year long range, so a move above has blue skies ahead with little resistance
Buying the 1 min ORB above 26.70, using a stop loss just under the low of the day allows you to enter this move by taking on just -2.3% risk
Buying the 5 min ORB allows you to enter by taking on -5.09% risk if using a stop below the low of day
This goes on to make a strong +119% run from entry in just over two months. No one is going to buy the low and sell the high, but catching a nice chunk of this move can really help make significant progress in your account.
What Qullamaggie often advocates is selling a portion (1/2 or 1/3) into strength in the first 3-5 days, and then trailing the remainder with a key moving average of your choice - typically the 10 or 20-day.
Market context is super important - buying such setups in weak markets is destined to decrease your win rate - see the dotted line marked below for the EP day in AAOI 0.00%↑A strong market backdrop helps this close strong and then go on a nice run:
AAOI 0.00%↑ 24 Feb 2017
This is an example of how the 1 min and 5 min ORHs coincide - they don’t all push out immediately, and they definitely don’t all work. The point is getting odds on your money over time, even if you have a win rate around 30%, a few 10R/20R or higher winners pays for your losers many times over:
Another example of how a strong market backdrop is supportive:
This is part 1 of a several article series on episodic pivots - throughout this series we will cover different types of EPs, failed setups and some additional selling techniques.
I hope you found this useful and let me know what you think!
