Hi folks,
I just wanted to create a step by step educational blog post highlighting last weeks Art of Trading's Top Pick of the Week; $KLAC short setup and an $IWM reversal setup I had my eyes on too!
Each weekend Art of Trading members receive a Stocks to Watchlist for the week ahead with actionable trading setups that I find during my weekend scans. Often the lists are concentrated into 3 - 4 actionable setups geared towards the current trading environment.
Last week the focus was on bearish and only bearish setups coming into the week. Setups had been failing into the week of July 29th and my thinking was the FOMC, FED meeting was likely to be a catalyst for further breakdown. $IWM continued to hold up while everything else around it had been failing and breaking down. $TZA made sense to take advantage of if the FOMC minutes is what helped crack the market for more downside and it did just that!
I think this is a great time to review short setups and how to anticipate and trade them with confidence even if its just a short lengthed cash flow trade much like $KLAC was last week!
$KLAC ended up on my radar because of the Bearish Power Earnings Gap it had put in on July 24th, 2024. Since that point it basically just chopped up in down with a range creating a bearish flag setup. This set of circumstances created a high probability short setup for the week ahead which ultimately made this stock the Top Pick of the Week!
Here is a quick refresher on what a Bearish Power Earnings gap is:
A “Bearish Power Earnings Gap” (B-PEG) is basically: A stock that gaps down after reporting weak earnings and closes the day by printing a very strong weak candle. A candle that closes at or near LOWS of the session, this is the most ideal and perfect “Bearish Power Earnings Gap” candidate! Volume will be automatically huge since it’s coming on news of an earnings report so that’s going to add even more conviction to the move since institutions are likely evacuating the name! Remember, it is important for the small players (us retail traders) to follow in the footsteps of the BIG GUYS (the institutions). Following these foot prints can be extremely profitable if you know what to look for! Stocks that gap down (especially stocks already in a confirmed down trend) on HUGE volume and close near the days low, are doing that for a VERY good reason! If the BIG sellers see future weakness, I want part of that too!
I use the B-PEG strategy often to look for stocks to short. I add these weak stocks to my watch list and I use technical analysis to find a great entry and when I feel the time is right, I take a trade! Remember you want to SHORT stocks that are ALREADY weak and this is a great way to spot these stocks and execute upon the weakness!
What would be an ideal entry on a short trade like this?
Anticipating the move is the important point here. The ideal entry should be closer to the upper area of resistance rather than on the lower side of support. This way you minimize the total risk of the trade and when it starts to work your entry is already much further off the point of the pivot giving you better reward and narrow overall risk. In the case of the Top Pick of the week we don't usually have the beauty of a "perfect" entry as the strategy is systematic in its approach. In this case our $787.99 entry was close to ideal giving the trade lots off room to work in either direction!
The stop loss on the trade has a lot to do with the point of entry too. We'll talk about that next!
How did I determine the $840 Stop Loss on the $KLAC short setup?
Since $KLAC was basically range bound since the Bearish Power Earnings Gap setup using a spot slightly above that price range was an appropriate spot for risk. The top end of that price range was $829.08 put in on July 17th. Sure this was before the Bearish Power Earnings gap day but within a 1 week timeframe. The second consideration on that is the daily price swings that the stock makes. A the time the average daily price swing of the stock was +/- $30. A very large range, just under 5% some days. So a stop slightly above the $800 spot of resistance and above the $829.08 range high made sense here. $840 would give the stock enough room to work itself out if it truly wanted lower!
How was the Target of $720 - $700 determined?
I use classic technical analysis to measure all of my upside and downside targets. Since this was a bearish flag setup I made the price target calculations off of that technical setup.
This is what that looked like on the chart:
Since this was a Top Pick strategy trade that we initiate at the start of the week and close at the end of each week we opted to take our $700 weekly target and close the trade early into the day on Friday. One important point to note with short setups is its usually never all that strategic to overstay your welcome. These trades move fast so they require the trader to be aggressive on the way in and on the way out. These same tactics would apply whether its a systematic or purely technical approach!
$TZA Section
The second part to this review is an overview of $IWM and why I thought it had potential to reverse. The basis to this was quite simple. Here was my thinking: Last week the focus was on bearish and only bearish setups coming into the week. Setups had been failing into the week of July 29th and my thinking was the FOMC, FED meeting was likely to be a catalyst for further breakdown. $IWM continued to hold up while everything else around it had been failing and breaking down. $TZA made sense to take advantage of if the FOMC minutes is what helped crack the market for more downside and it did just that!
Its one think to have a thesis but executing the plan in a technical manner can be in another league of its own.
I noticed that $IWM had the classic "perfect" looking bullish breakout setup that many were talking about but under the surface many setups were failing and $IWM was the last soldier standing. I take big notice in circumstances like this. I figured the FOMC / FED talk was likely the catalyst the market needed in order to send it lower.
So what is a 2B reversal pattern?
2B Bottom Reversal Patterns can occur on mulitple time frames. In this pattern a low is set (1.). The bulls take control and run the price back up slightly. The bears then start to win the fight and the price is pushed below the previous low. Losing support! Support is lost but soon after the price drives higher (2.). Clearing the previous low (1.) Bears start to panic and bulls pile in making a reversal! (3.)
Its important to note that this pattern works both ways. You can flip and for the same effect.
In the case of $TZA the pattern illustrated above was what was used for the setup!
I let Art of Trading private members know about this development in real time!
The setup quickly played out in spectacular fashion the very next day!
The beauty of a 2B reversal pattern is the downside risk is measured precisely with the candle that forms and initiates the setup. The stop can be set slightly below this low for a very favorable risk vs reward trade!
Keeping an open mind and opening up your book of trading experiences and reliable technical patterns can be very lucrative for short term, quick in and out type trades in the market. Honing in on your entry tactics and being able to decode potential setups before the major move happens is what will set you up to be above the rest!
Thanks for reading! I hope this step by step educational blog post unlocks some new knowledge helping you along within your trading journey!
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