It’s Earnings Season…Mind the Gap

01/19/2012 7:00 am EST


Earnings season features plenty of gap-ups and gap-downs, so it’s a good time to be alert for stocks moving fast, says day trader Troy Peterson, who argues that this advice is as applicable to investors as his fellow traders in the current environment.

Kate Stalter: Today, I’m on the phone with Troy Peterson of Gap Edge Trading, and as the name very well describes, you have a focus on gapping stocks. But tell us in your words what your methodology is.

Troy Peterson: Yes, usually you watch stocks that are gapping pre-market—before the market opens—related to news or in reaction to the news or earnings. We specifically use our indicator as that prior price action. We look for previous areas on the chart in regard to the gap, and we play off supply and demand from the gap for those areas. That’s specifically what we do.

Kate Stalter: I just wanted to ask you a couple questions off of that, then. You had specified pre-market specifically, which is when a lot of news breaks. But how about after hours?

Troy Peterson: After hours—oh, absolutely. I gather a list after hours, post-market, and we go over those areas that are gapping post-market and those gapping pre-market. So, hopefully for the open, those gaps will remain, and that would be our focus.

Kate Stalter: Now, you mentioned a moment ago the prior price action. Give me some more detail on that. That’s pretty interesting.

Troy Peterson: Yeah, we don’t use indicators. We look to identify supply.

We know where the sellers are, and try to know what the demand is, to join the buyers. So, we’re pretty much reading what the action is telling us, and we would go from there in those areas: Topping out, bottoming out, looking for congestion areas on a bigger timeframe, the daily, the 60-minute chart.

And if the gap is too far away from those 60-minute or daily charts, we’ll then try to ID the supply and demand intraday, from what basically is intraday pivots, prior lows, prior to the highs.

Kate Stalter: When you’re talking about supply and demand, that implies that volume would play a role in your method as well?

Troy Peterson: Yeah, when we evaluate volume, we’re not trying to second-guess the market or anticipate any moves. We’re just trying to say, “OK, where are the sellers at?”

Usually it’s a specific area where the buyers are at. It seems to be pretty concrete that once you identify an area of sellers, and the area can change, too, intraday.

Once a pivot is taken out on the upside or the downside, that can become a new area of demand or supply that you would watch for price action.

So, we’ll take a position into an area that is confirmed, supply or demand, and give it room. If it goes against us a little bit, maybe add into it a little bit. Everything is pretty defined that we do.

So, we have a level, like level one, or level two supply. We rarely do get level three supply or demand. But we try to predefine these areas before the market opens.

Kate Stalter: One of the things I wanted to ask is: How do you determine an exit strategy?

Troy Peterson: Well, I do a specific proprietary way we do trades. But basically, the exit strategy: Once we’re in, if a stock’s already made a prior low on the day, and then retraces back up, say, it’s a gap down, and the stock is like gap down, and it’s had a good run for the first 20 minutes or 15 minutes when we open, and we will watch it.

If it retraces 60-minute supply, we’ll gauge it, and we can initiate the short into the 60-minute supply area. Then we’ll watch the prior low from the open, so that low of the day around the open would be the area that would be our first target.

So, we wouldn’t take a trade that wouldn’t give us a good R/R, a good risk-reward. So, we at least look for 3:1, so if these trades could get 50% from that move down, we would look for our first target to be the prior low, that low of the day.

Kate Stalter: Tell us about any examples of recent stocks that are working that you can mention for us today.

Troy Peterson: Today, for example, in the Gap Trading System, CareFusion Corp. (CFN) had a pretty big gap down. It gapped down into $24.60 this morning, and it started selling off. It actually wasn’t gapping pre-market on the radar, so we actually caught it from after the open.

So sometimes we find laggards that maybe just gap right at the open, which is perfectly fine. We’ll watch those, too. We just don’t have our sights on them at the open. It actually had a nice, good run. It opened at $24.47, area and then sold off all the way to $22.19, so it opened the range up. So, we like to see that.

We like to see the stock make a nice, solid sell move at the open. We call it expanded range. Then it gives a nice retracement into that sell-off, then we look to trade into that area.

Kate Stalter: OK, I’m looking at that. That was quite a nasty gap down that happened in that stock…but it sounds like you have a way of getting into these and shorting them and making them work.

Troy Peterson: Our actual entry was: We went short at $23.99, and we scaled out, so we took profits along the way when the prices were low in the $22.50s, and then we took our final exit at $23.30 today. So, we got most of the move down, and then it kind of gave a few move pushups into $22.50 that could have been shortable also today.

Kate Stalter: Do you have others you could tell us about?

Troy Peterson: That was the only one we did today. Surprisingly, today was a pretty quiet day on the gap side. The last couple weeks of trading have been kind of slow for us, because there’s kind of a lag time.

We always call earnings season “gap season.” It kicks off with Alcoa (AA), because we always see so many gaps during the earning season, which, you know, everybody’s just buying the news. So, we tend to make most of our bread and butter during earnings season, which we’re actually excited about that kicking off.

So, like last week, for instance, we traded Costco (COST), and Costco gapped up on Tuesday, when the market was even higher. Well Costco showed up on our radar because we had some the week before. It gapped down, and we had a good trade on it.

Then last week it also was gapping down a little bit at the open, and markets moving higher, so playing some of that weakness. It showed some nice retracement into that gap down that we were actually shortable last week. I think it was actually Thursday and Friday were the days, two good shorts on Costco.

Kate Stalter: Then another one on Monday.

Troy Peterson: Yeah, and today. Today, I had a nice smooth count also. So, definitely some bigger players let some air out of Costco, so probably look for a bounce now into $78 at some point.

Kate Stalter: One last thing I just wanted you to ask you about: Do you advise folks who are listening to this, reading this interview, if they’re interested in learning more about your methodology, understanding this, in addition to visiting your Web site, should they be tracking earnings season? Watching the news, watching the pre-market action? What are the things that they should be looking at?

Troy Peterson: Yeah, absolutely, that’s a good question. You know, because as an asset trader—I’m specifically a day trader—but as a trader, we always need a vehicle to trade. Right? In terms of what do we trade? That’s the first question that you have to ask yourself.

When I started trading, I was really attracted to gaps because I’m on the West Coast, and I was able to trade the first 90 minutes of the market while holding a full-time job. That gave me a great attraction to developing a strategy in a way that I could still work and develop my edge, with employment, until I could do this full time, which I have been doing for quite a while.

By knowing stocks that are in play—because normally a stock will have an average range it trades at, 50 cents or 75 cents. It just depends on the stock. But when a stock will react to news, whether there’s a CEO resigning or guidance has changed, something—either it’s speculation, something—and that usually will attract the traders, investors, these bigger players.

And that’s what you want: You want to be part of something that’s moving, that the range is expanded, that the volume is expanded, and that it’s trending. That’s typically what occurs with a stock that we would call a “stock in play.” That’s what we look for with a gap.

You want to see stock that’s moving on abnormal buying, like CFN today had abnormal buying comparatively to what it did before. We want to see players there, because we want to play with other players. We don’t want to play when the stock is just flat.

They say don’t ever drink from still waters? Well, don’t trade from stocks that aren’t moving, right? You know, a stock that’s flat. So, we want to drink from moving waters, you know, something that’s moving, that’s what we want in the market, when we trade. We want to see something that’s moving.

So, the attraction for me in trading gaps is there’s momentum, there’s trending, there’s more buying, there’s more players, and there’s a bigger range.

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