Stock trading consists of 4 major types of trades.
The range-bound trade: the stock is tied in a range and will remain there until there is a significant change in the supply/demand dynamics. For this trade you fade any move to the boundaries of the range with a tight stop a little bit below/above the range. If the range is broken, you will lose small amount. It is good for scalpers with shorter trading horizon.
The breakout trade: in order to break from a range, a stock needs to experience a major shift in supply/demand. A dramatic occurrence. News or expectation of news. The news doesn’t have to be connected with the individual stock. It might be something that impacts the whole industry or market. Sudden change in participants’ confidence. Not every breakout will be caused by clear news. Often it will happen at no news at all. In any case, volume should be your tell how genuine the move is. Buy several cents above the range with a stop several cents into the range.
The reversal trade: not every breakout is genuine. Ranges are often manipulated in order to deceive market participants and free them away from their money. Again volume or more precisely the lack of volume should assist you in taking a proper decision. Once you notice that the breakout is fake and the move exhaust itself, fade it with a target the upper boundary of the old range and stop the high of the day.
The trend trade: high-volume breakout from an extended range often starts new powerful trend. Many traders complain that they have missed a certain breakout, without realizing that if that breakout was genuine there would be multiple other opportunities to jump on board as the new trend evolves. Trend trading consist buying/adding at the dips or selling/adding at the rips. Entries on pullbacks offer a lower-risk way to participate in an established trend.
All 4 types of trades occur on different timeframes. What looks like a breakout trade on a 10 min chart might be part of a range-bound trade on a 1 day chart. Traders should specialize in one type of trade and in one timeframe, depending on their personal skills and preferences.
High-volume break-outs from prolonged in the time range is usually a start of a new powerful trend. The larger the volume and the longer the consolidation level prior to the break-out, the better the odds that the newly established trend will continue.
“One common adage on this subject that is completely wrongheaded is: you can’t go broke taking profits. That’s precisely how many traders do go broke. While amateurs go broke by taking large losses, professionals go broke by taking small profits. The problem in a nutshell is that human nature does not operate to maximize gain but rather to maximize the chance of gain. The desire to maximize the number of winning trades (or minimize the number of losing trades) works against the trader. The success rate of trades is the least important performance statistic and may even be inversely related to performance.”
No other quote illustrate better my trading during the last two weeks. I was right 14 times in a row, but my account didn’t appreciate significantly due to my premature exits. It is true that my timing was often correct as I was lucky to exit minutes before my position turned against me. This especially well relates to my countertrend trades. But it is also true, that I left too much money on the table by jumping out of stocks that were just beginning to move; trades that for some reason were all in the direction of the trend. In hindsight, I realize that I wasn’t chasing profits. I was trying to be right as often as I could, often scalping for meaningless profits.
Then on my 15th trade I took a big hit, that wiped out half of my two week profits. I made all the mistakes that an amateur could have made. Initiated a position in a leveraged ETF not for a day trade and not to hedge my other positions. Entered a trade that was in the opposite side of the prevailing trend. Essentially I bought the rip – the very place that professionals often use to renew their selling, as it offers excellent risk/reward. I put good money after bad by averaging down in a losing position. I did that even after realizing that my position in a 3x ETF should be three times smaller than the average position I take due to their extreme volatily. I turned a trade into an investment. My initial entry was profitable and I had the opportunity to exit with good gains two days in a row. I didn’t. I saw my position going against me and instead of exiting immediatelly I decided to buy myself some cushion by selling front month OTM calls against my equity. The cushion wasn’t enough, so I averaged down. I created a position that would be normal for my other lower betta trading vehicles, but way too big for this leveraged ETF beast. Last Friday I exited with a 2.5 points loss.
It’s much easier to learn what you should do in trading than to do it. Good systems tend to violate normal human tendencies.