What to do the Day After the Trade is Executed
As with when to trade and how to enter, the following day’s activity depends on whether the stock gaps up/down or not. If the stock price doesn’t gap up or down, the stop loss is changed based on the previous day’s prices. If the stock gaps up or down, the stop loss is changed based on the current day’s prices. Whether based on the previous day’s prices or the current day’s prices, stop loss rule is the same.
• When the stock opens within 50 cents ($0.50) of the previous day’s close – if 6 cents below the previous day’s low is higher than yesterday’s stop loss, raise the stop loss to this new price. This is known as raising the trailing stop, which further limits the downside risk.
• When the stock gaps up or down 50 cents or more – wait 30 minutes for a gap down or 5 minutes for a gap up – if 6 cents below the today’s low is higher than yesterday’s stop loss, raise the stop loss to this new price.
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Gaps
Playing the gap is one of the most powerful trading techniques you can employ, and it is particularly useful for making a “quick buck,” once in the morning. We call this the Dumb Money Gap Down, or “DMGD.” It is when a stock opens substantially lower than its previous close, or plummets sharply soon after the opening bell.
The technique is based on the fact that inexperienced (”dumb”) investors will frequently buy or sell stock before the market opens. If such pre-market action is to the sell side, the stock will gap down, which means it will open below where it closed in the previous session.
Although we refer to stocks that gap down (open lower), a DMGD includes a stock that opens flat, or even slightly higher, but quickly plummets during the first few minutes. Whether this occurs right at the bell or shortly thereafter, the theory is the same: the “dumb” money sold the stock.
Why “DMGD” Works
The theory of the “DMGD” is that no real professional would ever sell stock first thing in the morning without a compelling reason to do so. Hence, any sharp action in either direction is due to inexperienced traders. And, more often than not, the “smarter” money frequently swoops in to drive it back up. Using proper timing, you can usually catch the bounce and make substantial gains in only a few minutes.
Another reason that stocks gap down sharply is that the less experienced traders and investors will overreact to news, or to an analyst downgrade, etc. The interesting point about this is that the DMGD strategy tends to work even if the stock is gapping down for a “reason.” More often than not, a reaction to a negative event is overdone, sometimes blatantly so.
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