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8 Steps to a Price Spike Fade Trade

07/12/2013 6:00 am EST


Michael Bellafiore

Author, One Good Trade: Inside the Highly Competitive World of Proprietary Trading

We are seeing more price spike opportunities because market makers today are algorithmic programs, says veteran trader Mike Bellafiore of SMB Capital, so traders should learn to add this set-up to their playbook.

I’m writing this post for one of the most gracious traders on my desk who should be in more of these plays. He is a terrific tape reader, scalper, and intraday trader. I can see him doubling his P&L by mastering this trade.

I made a price spike fade trade in Verifone Systems (PAY) yesterday that with the right trading technology can pay (pun intended). Our desk created the SMB Radar, which alerts our traders to price spikes. The SMB Radar picked up a price spike in PAY as you can see from the chart below. There is money to be made fading these prices spikes. Let’s discuss the price spike trading strategy.

  1. You need filtering technology that alerts you to price spikes.

  2. You need a news feed to check to see if there is breaking news causing a legitimate price spike. Breaking news can affect whether you fade this move. A lack of breaking news and you will most likely want to fade this price spike. I checked my news feed and did not see any breaking news in PAY. Traders on our desk have their news feeds built into their trading platform. If there is breaking new news in a stock, they are alerted in a window they have linked to that trade symbol. This is pretty cool.

  3. Wait for the tape to change. Watch how PAY is trading higher and higher and higher on the tape. And then wait for the buying pattern to change. For the offers to stop being taken as they were on the way up. See the change on the tape. You need tape reading skills to take advantage of this pattern.

  4. Short only when you see the clear pattern change on the tape.

  5. Place your stops above the highest wick in this upmove.

  6. Play for a reversion to the mean, covering into a downmove back to the breakout area.

  7. Pay (pun not intended) for the trade by covering 1/2 into the first downmove, as I did at 17.93. This will allow you to make money on more of these trading patterns, as generally there is a downmove even if the stock will find a way to trade above the highest wicks.

  8. Hold the rest for a steep move back to the breakout area. In this case, we did not get that steep move all the way back to the breakout area so we have to cover near 60c.

There are numerous price spikes intraday where you can apply this strategy. Like all setups, it will take time to master this trade. For example, we had a similar price spike in Kla-Tenor Corp. (KLAC) later in the day. You could tell into the first pullback from the price spike that it was not as weak as PAY and had a much higher probability to continue higher. With the KLAC opportunity, you needed to cover into that first downmove.

We are seeing more of these price spike opportunities because our market makers today are algorithmic programs. When multiple buy orders flood the market, the algos run away from the offers and the stock spikes. There doesn’t even need to be an increase in volume to see a price spike with our present day market structure.

Click to Enlarge

For the active, tape reading, intraday scalper, you should add this set-up to your playbook. We are seeing more of them. And a handful of these in one day can manifest some serious P&L without very much stress and risk.

By Mike Bellafiore, Co-Founder, SMB Capital

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