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 MARKET REPORTS |
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Resident trader
Trading for that big catch
Will Kraa, April 17, 2008
Recently I wrote about my strategy of buying small companies that experience a price and volume breakout, usually at the time good news is released. To read the article go to http://www.compareshares.com.au/kraa41.php where you will see that I made a good profit recently of over 76% in just a couple of days. Certainly, there haven’t been as many candidates for this kind of trading lately, but in the current market that’s not surprising.
Last week on 7 April my daily scan showed that a company called Redbank Mines (RBM) had suddenly leapt in price from around 2- 3 cents to about 6 cents with an enormous increase in turnover. I quickly looked at my webIRESS platform for any company news and discovered it had found a “spectacular” high grade copper ore close to the surface. It was certainly something that excited the market. I don’t profess to have any expertise as to what is a truly spectacular discovery but I don’t need that. The price action tells me there are plenty of others out there who think so. The last time I traded one of those copper discoveries it was a company now called Cudeco Limited (CDU) and the price went from about 40 cents to $10 in a few days before settling around the $3 where it still trades at present.
I made a lot of money from that one, but could have made more if I’d known what I know now about trading such stocks. That particular trade was the sort I particularly like – the price had been trading largely sideways for a long time before jumping up over a period of days. You can see it on the weekly chart below.
It was important to check the exposure of RBM to the Opes Prime disaster. The company’s shares were exposed to Opes Prime but the number was relatively small, meaning that the shares could be easily offloaded within a day’s trading without impacting the price level too much.
RBM certainly is a different chart to CDU and more similar to the KEY trade described in the previous article as it had been in a very consistent downtrend since the last “significant” copper discovery in January 2007. It was therefore a very different trade to CDU from the outset - and so not one I’d want to hold for too long if the price didn’t keep rising. As can be seen on the chart below the price had risen to over 6 cents by the time I did my scan and checked the news. The risk was that the shares would revert to their usual price. I’d certainly get out if it fell to the opening price for the day, of 4 cents. So by the time I was able to place the trade, the price was at 6.4 cents for a risk per share of 2.4 cents. As in the last trade I was willing to risk $1,200, which is about 2.5% of the value of the account allocated for these trades.
With a risk per share of 2.4 cents and risk for the trade of $1,200 this meant I could buy 50,000 shares. I was filled at 6.4 cents. As can be seen on the chart, the price went to 8 cents, meaning I could have exited with a profit before the end of the day. If I’d done that my profit would’ve been less than my initial risk. While it feels good to take a profit, there is no future in trading where the profit is less than the risk. I am not one to subscribe to the fallacy that you can’t go broke taking profits.
As is usual for this kind of trade, by the end of the day the price had retreated to 7.4 cents. Generally by the end of the day there are day traders who want to exit, leading to a drop in price before the day is out.
The next day the price dropped more but I was willing to give it some more room to move. But the day after it was down again and it was clear that the excitement of the copper discovery was over. The reason for taking the trade was now no longer valid and so I exited on 9 April at the price of 5.4 cents.
This meant a loss of 1 cent per share or $500 plus commission of $33 each way.
It was a successful trade that did not make a profit. I had limited my loss and it was certainly small compared with the profit of the previous trade. If I had got out at the end of the first day I would have made a profit of $500 but it would not have been a successful trade as it would not have been consistent with my trading strategy. In this trade it would have been better as far as profit is concerned, but if I did this with most trades the profits would be cut short and the strategy would no longer work.
By limiting losses on trades, you can have a profitable trading strategy even if the ‘hit’ rate of profitable trades is not very high. Trading these stocks is by many considered too risky but if you are able to have a set risk per trade and take the losses as they occur the risk is controlled and known before the trade is entered.
It is very important with this kind of trading to get out promptly once it becomes plain that the reason for entering the trade is no longer valid. You can see on the chart that once the excitement is over the turnover drops off quickly and it gets harder to exit the trade at a reasonable price.
This strategy can make spectacular profits but this does not mean it is infallible. There are times it does not perform as expected and then the trade needs to be terminated promptly. If you are not able to do that it may be best to avoid this kind of trading.
The truly windfall profit trades such as CDU or IDL do not come along every day but I will continue to take the more ordinary trades. Overall they are very profitable and then every now and then there is the really outstanding one that makes a huge profit. The steady profitable trades have made a very substantial increase in the size of this account. The good news is that when one of the windfall trades comes along, the trade size can be larger and the results can be phenomenal.
More articles from this edition of CompareShares:
Superannuation: Keeping super and pension balances safe during market turmoil
Stocks: Big cap stock that defies market sell-off
Commodities: USD gold bull
Fundamentals: It pays to avoid dud stocks
Analysis: The biggest speculative bubble in world history has some unwinding to go
Resident trader: Trading for that big catch
Investing: Have we witnessed the market bottom?
Investing: Confounding connections – Aussie market following the US like a dog on a leash
Whatever your views, you can discuss this article - or any of Will's articles - on our message board Your 2 Cents.
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