Trade Review: How I Shorted Baidu.com

05/23/2011 11:05 am EST

Focus: STOCKS

Heavy volatility in Chinese Internet stocks like Baidu.com (BIDU) offered good trading opportunities. Here is how one trader played it, as well as some important lessons learned along the way.

One set-up with which I recently had success was found in Baidu.com (BIDU). Although the money has been made on this trade, there are still some lessons we can take away, so let’s take a closer look at the trade as it evolved and see what we can learn from it.

The entire Chinese Internet stock group had been weakening as of late, with names like Sohu.com (SOHU), Sina Corp (SINA), Netease.com (NTES), and others beginning to struggle. 

This follows months of leadership, as these stocks made big upside runs by building bases upon bases. The momentum shifted a few weeks ago, and in every case, these stocks topped prior to the market’s pullback. (That’s why they call them leaders.)

BIDU did the same thing, having peaked in late-April ahead of the major averages like the Nasdaq.  Once the overall market began to pull in, these stocks accelerated to the downside, providing further evidence of an important change of character. 

Having become oversold, they rebounded, but in a lazy fashion. This set up quite a few bearish patterns, with the rising wedge being found in BIDU. I highlighted this pattern previously, looking to short BIDU upon a break of the lower trend line at $139.50.

chart
Click to Enlarge

BIDU broke that rising trend line just a day after its counterparts NTES and SINA did. That offered not only a clean entry for a short sale, but also a stock that had potential to play catch up on the downside.

I set a pair of targets for booking profits at $132 (yellow line in chart below) and $127.50 (red line on chart below), respectively. Target one was reached on day three of the breakdown, which was just slightly ahead of the Feb. 14 high in case it were to be tested. Target two was reached on day four, and that level corresponded with the lower end of the same mid-February congestion zone.

NEXT: Latest Look at BIDU Chart; 4 Key Lessons from This Trade

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While this stock eventually overshot my $12 per share profit target, it became oversold. Anytime a stock moves too far, too fast, it’s time to watch for a snapback. BIDU has done that in the past two sessions, but it remains technically damaged. Here’s a current look:

chart
Click to Enlarge

This stock and the others in the group are currently bouncing from their lows, but they remain in a bearish series of lower relative highs on their daily charts. That is to say that this bounce may get sold into again, so although this short sale is long since over, we have no evidence yet to support a lasting trend change. Until we do, these are stocks to watch for new short-side entries to emerge.

Four Important Takeaways from This Trade

First, clean patterns are the place to focus. They make it simpler for me to recognize when to be in a trade, and perhaps most importantly, when to be out of the trade. Tighter, more well-defined patterns help me be decisive, and in this game, that’s huge.

Second, stay on top of the sectors. While it’s a bit harder these days to play follow-the-leader when it comes to sector moves, it can still be done with success. Take note of which groups are shaping up for advances or declines, and work the charts for favorable candidates.

Third, when you get your move, ring the register. Greed could have kept me in this trade for a little bigger move, but it also could have kept me in for too long, leaving me now to wonder what to do on the current bounce. Blend the info you get by looking left on the chart along with the pattern projection to come up with an exit strategy…then stick to it!

Fourth, (and this goes hand-in-hand with the previous note), sharper moves are more prone to reversals. When your targets are in sight (or already hit) and the move is getting a bit stretched, expect the rubber band to snap back at least part way. Tighten your stops, book gains, and generally start expecting an imminent exit. Pigs truly do get slaughtered!

Here’s to your next trade—whether a winner or loser—and your commitment to take from it what you can, be it profits, a lesson, or both.

By Jeff White, trader and blogger, The Stock Bandit

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