Wednesday, October 7, 2009

As all of the trade reviews I have written to date have highlighted a winning trade, I wanted to discuss a losing trade in order to explain what our traders were seeing and how they reacted. The trade is Jabil Circuit (JBL) from last Wednesday’s open.

The very first question TradingRM traders ask themselves before entering a trade is: “Is this stock in play?” Before the open, JBL had posted better-than-expected earnings and gapped up roughly 6% from the previous day (see daily chart at left below-click to enlarge). The strong earnings and premarket move were a catalyst that told our traders that JBL was a possible long in play. When the market opened, that upward move was confirmed on solid volume. As shown in the 15 minute chart at right below, JBL was trading on extraordinary volume during the first 15 minutes compared to the previous day’s activity.

Another factor that our traders were considering was JBL’s relative position to the market. As shown in the 1 minute chart below (click to enlarge), JBL (green) started trending up, while the SPYs (red) started to fill the modest 4 handle premarket gap up. Approximately the time the relative positions converged, our traders decided that the earnings catalyst, confirmation on large volume, and the relative position to the market were all signs that JBL could be going higher. As shown by the TradingRM real-time blast, our traders started buying calls around 8:40 CST and continued to find pullbacks for entry over the next ten minutes.

During this time, the market formed a base and started moving sideways. JBL held strong and maintained a good relative position. However, volume began to dwindle, the stock started to chop, and implied volatility was sucked out of the option prices. As bids in the options fell, our traders managed risk and exited when loss targets were reached.

The lesson to emphasize is that not every trade can be a winner! In fact, even experienced traders have win rates of 40%-50% (trading on a similar time frame). The way to sustain long run profitability is to set good risk management parameters. By adhering to profit and loss targets, a trader can have an average win twice as big as his/her average loss. This rule-based approach is a big part of the TradingRM edge.

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