Trading a Previous Day’s Price Action

11/29/2011 8:00 am EST

Focus: STRATEGIES

Steven Spencer

Partner, SMB Capital

See how a professional trader carried prior price action on NetFlix (NFLX) into Black Friday trading in order to generate a viable set-up despite a shortage of market-moving news and economic reports.

Prior to the open of Friday’s shortened trading session, there was not much in the way of fresh news catalysts to move stocks. So my first trading choices were “second- and third-day” plays. We trade moves that are a couple days old based on the previous day’s price action.

NetFlix, Inc. (NFLX) was at the top of my list for potential short plays. Earlier in the week, fresh news had caused it to gap down to $69 and it then rallied about four points from this price. As a short-term trader, I am highly attuned to prices from which a stock rallies or gets crushed in the preceding trading days. I have found over the years that these prices generally offer the greatest risk/reward entries for intraday and multi-day swing trades.

Take a look at a 15-minute multi-day chart for NFLX for last week. I have highlighted two price levels with horizontal line segments. The line segment at $69 is a reminder that NFLX rallied from this level and is a dangerous short if it is trading above this level.

The second line segment at $68.50 is where NFLX supported the morning of the second trading day after the news was released, as well as that day’s closing price. If NFLX were to hold below this price level, it could be the beginning of a move lower.

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Below is a screenshot from Friday’s gameplan, which is a written summary of the stocks discussed in our morning meeting prior to the market’s open.

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Now take a look at the two-minute chart below from Friday’s price action. NFLX traded above both of the highlighted resistance levels from the morning meeting, but notice that it fails to hold above $69 and then spends the next ten minutes bouncing between $68.50 and $69.

This failure to hold a bid above $69 for more than a few minutes on the open is a signal for more aggressive traders to initiate a small short position. At 10:00 am, when it breaks below $68.50 on heavy volume, there is further evidence that a significant down move may be in the cards, and this is where a more conservative trader could initiate a short position.

I have further marked up the chart below to highlight the tight horizontal consolidation where traders could start to build larger short positions with very well-defined risk.

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This is a good example of the types of plays you can look for on a slow news day where not much is happening. Of course, you never want to force a trade that isn’t there. Slow news days require just as much discipline as days of high volatillity.

By Steve Spencer, trader, SMB Capital

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