The How and Why Behind My Goldman Sachs (GS) Trade

10/26/2010 12:01 am EST


Steven Spencer

Partner, SMB Capital

Last week, I traded Goldman Sachs Group (GS) and lost money doing so. I want to share with you the idea behind the trade and explain why and where I entered and exited.

It was a second-day play following their earnings release on Tuesday. GS has been showing signs of life recently, and after observing Tuesday’s price action, I was fairly confident it could trade up to $160. And perhaps over the next two weeks, trade up to $170.

We discussed GS in our daily morning trader meeting at SMB Capital, and I clearly outlined my initial buy area of $156.50 based on prior afternoon support. One of our traders who had been trading it the prior day pointed out that it had an explosive move from $155 and it would be a great potential pickup at that level as well.

Here is an outline of the trades I made and how I lost money. You will see some of the trades were actually missed trades. It is always easy to find excuses for missing trades, but the reality is that if you are at your trading station, there are no excuses.

  1. Initial buy at $156.52 with nice bids in the mid 40s. Popped up a quick 75 cents, so sold some, but eventually stopped out of position below $156.25

  2. Watched it trade all the way down to $155 where there was an identifiable buyer at $154.97. Quickly moved away from this level and I was not aggressive enough to get long at higher prices.

  3. Selling pressure at $156 and stock was still in a downtrend from prior afternoon, so hesitated to buy on the break above this level.

  4. After seeing confirmation that the momentum was back to the upside, I bought on a pullback from $157.75 to $157. Placed my stop at $156.89 and left the desk. Stop should have been below $156.80, but I bought a bit too much above $157, so gave it less than the appropriate risk.

  5. During the next 30 minutes, $156.90 established itself as clear support, but I was not at my trading station.

  6. Returned to my trading station at 12:15 pm to prepare for Right as I began to broadcast, GS breaks above pre-market resistance of $158

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Now, let me share a bit more of my analysis on why I was interested in trading GS the day following earnings, and specifically how I selected possible entry points for trades.

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GS is one of the most difficult market leaders to trade intraday on a daily basis. In common trading parlance, it does not trade “cleanly.” So unlike a Baidu, Inc. (BIDU) that I believe can be traded almost on a daily basis for consistent profits, GS needs some type of fresh news or technical catalyst to present good risk/reward trades intraday.

GS reported earnings on Tuesday and had some fairly bullish price action. It did sell off in the afternoon, but the SPY got clobbered in the afternoon as well. The market action overall bode well for GS in that each hard individual selloff in the market has recently been followed by the market being bought the following day (I’m pretty sure most market participants are aware of this pattern at this point, so be prepared for two hard down days in a row soon).

I have added the weekly chart below to illustrate my overall view that GS had clearly established a yearly low and had begun to reassert itself as a market leader. It had rallied on a percentage basis from the beginning of September more than the SPY and clearly had separated itself from the withering retail financial names. So I was mentally prepared for more market players to put money to work, and if offered low-risk/high-reward entry points on the long side, I was going to take them. Also, if GS closed above $158, I was prepared to hold some as a swing position.

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Now to the actual trades:

  1. The first trade was the riskiest as it was taken in the first 30 minutes of trading when price discovery tends to create some pretty interesting gyrations. But I clearly told our traders in the morning meeting that I was going to buy in the $156.50 area based on the prior day’s afternoon support and was not going to walk away from that commitment. As GS traded down to $156.50, there was some good-sized bids in the mid-$156.40’s offering me protection and information on how strong the sell interest would be below this level. This entry point can be described as both technical and tape-oriented. Using a support level from the prior afternoon as a technical indicator and watching the bids/offers on the Level II and not seeing aggressive selling at my possible entry point gave me confidence to get long.

  2. The second entry point I mentioned was $155. This entry price was brought to my attention by one of our traders who had watched GS the previous day. GS had an explosive move from this level the prior day. Stocks tend to support levels from which they had explosive moves if they return to those prices not too far off in time. For intraday trading, this means that if on the second day, a stock trades down to an inflection point from the previous day, there is a high probability that it will bounce from this level. It turned out in this specific instance that there was a clear buyer on the tape at $154.97 presenting an opportunity to get long, which I previously stated that I failed to act on. My hesitation was mainly a function of the fact that the intraday momentum for the stock was down, so my instinct was to wait for more confirmation that GS would turn back up. That hesitation brings us to the next possible entry point.

  3. You can see on the 15-minute chart below that after bouncing from $155, GS ran out of steam at $156.  There was selling at this level, but there was a very shallow pullback. This price action was indicative of a downtrend that was beginning to turn. When the sellers lifted at $156, GS had an explosive up move, which signified a change in its intraday trend. Coincidentally, an algorithm that I run that measures change in momentum signaled a buy when GS traded above $156 as well. I have been testing this algorithm for two weeks, and each time it has offered a signal that matched with my own discretionary trading decisions, it has been successful.

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GS continued to trade higher, topping out at an intraday high of $157.80. At this point, I was very confident that it would now trend up for the rest of the day, so I was interested in being long on a pullback. I began to look for the down move to slow as it got closer to $157. I initiated a long position at $157.20 and bought some more at $157. The correct stop for this position was below $156.80—a point from the high. I set my stop below $156.90, which was 30 cents from my initial entry. I have found that if a stock trades more than 30 cents against me, I rarely wind up in a winning position. The problem with the 30-cent rule in this instance is I used it from an aggressive initial entry point and not from my “dream” entry point of $157. I was stopped out at $156.89, but the stock did not trade lower. I was already off the desk at this point working on firm business.

  1. The next possible entry point was during the next hour, when GS would not drop below its retracement low of $156.89. This trade is 100% technical and is incredibly effective. When a stock has a change in direction/momentum, eventually it has some type of retracement or pullback. Once this pullback is complete, a pullback low or high is established and this price can be used as a stop for a position that you initiate in the direction of the larger trend. As you can see from the chart, this pullback low was never violated the rest of the day.

  2. The final possible entry in GS was when it traded above its pre-market and intraday resistance of $158. This entry point had three factors in its favor: 1) Stocks that trade above their pre-market highs tend to trade higher; 2) This level had been tested earlier in the day and was rejected on heavy volume, establishing as a clear inflection point; 3) There was tight consolidation right below the level, showing strong interest from buyers; and 4) There was a strong increase in volume as it broke above $158, confirming the uptrend for the day. Note that this increase in volume at 12:30 pm confirms that many were interested in being long as it got above this key level, even if it was the middle of the trading day.
By Steve Spencer, trader and blogger, SMB Capital

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