Anatomy of a Gut Trade

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  • on April 16th, 2010

It’s not my bag to talk about winning trades…I always admired the Walter Payton and Barry Sanders approach to “act like you’ve been there.”  Not only that, this trade is still open, so there’s no way to know how it will evolve in full.  But there are valuable lessons in sharing the psychology behind this one, so I make an exception.

Each morning, I put some “In Play” stocks on my radar…these are situations where news has caused an early spike in trading volume and/or price range.  This is fertile ground for ideas because I know a battle is being waged for control of the trend, and if volume and range are high I can assume most important participants have come to play.  It’s these high activity battles that can leave clues as to the future outcome…I liken it to a goal line stand in football.

On Thursday morning, Inter-Oil(IOC) was among those names.  I know little about the company, but had heard some rumblings about controversial pumping and such.  A report was out about this supposed funny business a few weeks back, and after a big drop it shook it off and moved higher.  My subconscious probably has 2 ideas lurking…1st, that this company may be shady, and 2nd that its ability to weather that news may mean the company is legit.

Anyway, the stock gets on my board with a 6 point gap higher on heavy volume.  However, within minutes it starts drifting toward the bottom of my page.  I sort this page by some homegrown metrics I like to use, like “Distance from VWAP” and “Last vs. Open”…the stocks making progress from early trading will catch my eye at the top of the list, and those deteriorating end up at the bottom of my page.  This stock is glaringly at the bottom of my page, and I think…that weakness is interesting, but I’m a trend follower and the trend has been higher.  No play, I guess…too weak today to buy, but too strong over the last few weeks to short.

But I can’t shake the feeling that I should be short this name.  Again, I review…the last month is straight up so leave it alone.  A look further back, however, and the idea starts coming together.  Despite the recent move from the high 50’s to 81, it’s still not eclipsing its highs.  To me, that makes it a range-bound stock and not a trending leader.  Range bound stocks often see selling by “other” players when they approach old highs, so now I have both “day” and “other” sellers on my side.

I throw out a small line while investigating further.  It’s working, which is usually the best indicator of all…I add a little to my line and now have a full position short IOC.  Who would have thought?  I go through meticulous prep to find a name or two I can consider, and then here I go with a random trade in a controversial name?  Am I being impulsive, or is this instinct taking over?

A couple hours later, Dr. Brett puts this post out on Twitter about following hunches.  By this time I needed no reinforcement because I was ahead 3 points in the name…this was now a Trade2Hold in the lingo of SMB Capital.  After years of using various styles and time frames in attempts to capture entire moves, it became clear to me that the best long-term winners were trades gone right.  They may not adhere to every little rule I’ve created, but they honor most of them and do it right from the start.

IOC may not be a multi-week winner for me, but it has many elements I like in a short:  momentum traders, failure to make highs with a blistering bull market, inability to hold onto a news gap, and most of all…immediate profits on my idea.  I can at least operate in this name knowing I took something out of it on day one, and with critical resistance on my side where the “defense” made its stand.  My gut knew “Why?” before my brain figured it out.

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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