Last Thursday’s -200 point Dow gave a great setup for mean reversion traders. Using linear regression there were many names lining up on multiple time frames (30/60/90 day LR2) for long entries (see story). Generally it’s a bad idea to buy into a massive down day. Waiting a day or two the entry is often better. So let’s see how a few names did buying at Friday’s open. The following entries were after the 2nd 5min candle. So ten minutes into Friday’s open $10,000 was theoretically put into each of the following names.
Valid at close Wed. Oct 7th
Clues to Exit
So where do we exit these trades? The first is break even profit stops. Some of these names are barely holding on after a three day push in the overall market. It’s prudent to put tight reins on them and not let a small gain turn into any kind of loss. The bigger profits can be given wiggle room. When price runs back to the median line of your preferred time period a profit stop should be tightened. The optimal exit is when price runs to the top of the channel. Look at FCX:
For short term swing trades the 20 day channel is very useful. A tight profit stop here at the top of the channel is often ideal.
Shorting Gold Miners
Using this method several gold miners look ready to go short: AEM TLR VGZ THM and KGN are all at new year highs. The trick is getting price and time to align for maximum profit and minimum risk. Let’s look at AEM:
YTD
Price is near the top of the year to date LR2 channel. It's a 2 sigma move that should come back down, but there's some wiggle room.
60 Day
The lowest risk entry would be around $76 at the top of the channel. On a smaller time frame there's much more finesse to maximize the setup.
More Names for this Week
Keep an eye on FCX. It’s a great industry leading stock that will give clues to how gold and the miners will trade. The following names might be a little early to short. They are junior players that all made new highs today. Gold is a very difficult sector to trade and there’s lots of wiggle room. On the first sign of weakness these low risk trades could turn into quick profits.
KGN
THM
TLR
VGZ
Caution
These are probabilities not known outcomes. The market can do anything at any time. This concept assumes there will not be major news events or supply/demand shocks to upset the concept of mean reversion. The odds of price retreating from range extremes outweighs the risk of shock events. However, a maximum loss market stop is always necessary to protect one’s capital. It’s vital to use concrete money management discipline. Many swing traders will not risk more than 2% of their cash per week. If you’ve got $50,000 taking a $1,000 draw down is the max loss per week. That’s the cutoff point. It proves the trading edge for that week is wrong.
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