After NFLX gapped down following a slight earnings miss, we wanted to see how it would handle it’s significant support around 96. Would the shorts pile on or is it a buying opportunity? The days highlighted with the green circle were days in which the overall market was down significantly. If it were a weak stock, it would likely breach support yielding a swift move lower. However, it showed a ton of relative strength, signaling it would have a move higher when the market settled. We were able to initiate our swing trade at $100 and sold most of our position in the area signified by the yellow circle. It is very useful to use trend lines when looking to initiate positions as well as take profits.
Now let's take a closer look at this trade, looking at the hourly chart of NFLX during that period!
As we mentioned, the market was selling off, and if NFLX was weak it would have continued to sell off and break down lower, but after we noticed it was holding up, we were able to accumulate a 1,000 share position. Started first with a 100 share filler and adding more as we grew more confident in the trade. After, it broke above $100 and held above it. We had a hard stop in at $98.99. The risk in this trade was around $1,000 if it were to fail and stop us out.
How do we come up with $1,000 risk?
If we have 1,000 shares at an average price of $100 and our stop is $98.99
$100 - $98.99 = $1.01 x 1,000 share position = $1,000
We strive to make at least 5 to 1 or more on our risk.
Why is 5:1 risk reward so important you might be thinking?
Here is an example of 5 trades where we risk $1 to make $5 on a 100 share trade.
Trade 1 : Stopped out- Lost $100
Trade 2: Stopped out- Lost $100
Trade 3: Stopped out- Lost $100
Trade 4: Stopped out- Lost $100
Trade 5: Trade worked- Made $500
After 4 losing trades and only 1 profitable one we made $100, we only had to be right 20% of the time to still be profitable.
Now most new investors are greedy and sell their winners early. With an average risk reward of 1:1, let's try this same example again.
Trade 1 : Stopped out- Lost $100
Trade 2: Stopped out- Lost $100
Trade 3: Stopped out- Lost $100
Trade 4: Stopped out- Lost $100
Trade 5: Trade worked- Made $100
After 4 losing trades and only 1 profitable one that trade lost $400, even if he was right 40% of the time he would still lose money. To put that in perspective, Hedge funds are only correct in their trades around 35% of the time but they have great risk reward. That's why you need to understand how important proper risk reward is.
Back to the trade at hand, we had $1 of risk so we started to sell into strength, selling at $105 (5-1 Risk Reward), $108 (8-1 RR), $112 (12-1 RR), $114 (14-1RR) and getting stopped out of the rest around $110 when it made a new, lower low. The upward trend it was on for the past week was now over and we finished the trade with over $10,000 in profits on $1,000 of risk.
The main takeaways from this are:
- Starting small and adding as the trade continues to set up better
-Having a hard out and sticking to that out
-Having a game plan prior to the entry
-Selling into Strength (we are not here to call tops and bottoms but to ride the trend for the meat of the move)
Do you have balls?
Your task is to now go out and find 3 stocks that have clear lines of support and resistance and formulate a game plan for each and post them in the Chart Reading chat.
POST IN THE CHART READING CHAT
Keep up the consistency, only 25% left to go! Let's hear it in the chat “I only have 25% left to finish Chart Reading, I will complete it by (insert your deadline)!