Thursday, as I mentioned in the Columnist Conversation, we played Research In Motion Ltd (RIMM:Nasdaq) for an early bounce off the first bottom. Several people asked me how I came up with my upside target of 74 for that trade, so I thought I would go over the reasoning in more detail.
The first factor that came into play was a familiarity with the stock. We have a basket of stocks that we regularly play, and one of those happens to be RIMM. When you play the same stock every day, you get a feel for how they move, their average spreads, their normal trading patterns, their average intra-day price ranges, and what they are capable of. That kind of knowledge is invaluable. It helps you anticipate and judge the potential of a trade.
There are many people in my trading chat room making a decent living playing the same stocks every single day. One man that comes to mind has been playing Intel Corp (INTC:Nasdaq) back and forth, long and short, all day long, for about 10 cent gains at a time. That may not seem exciting, but if you add those gains up, averaging 50 cents a day, playing 5,000 shares, which is very easy to manage with Intel because it is such a high-volume liquid stock, you come up with a salary in the high six figures.
So we normally keep a basket of stocks that we focus on for daily trades. If one of those stocks is affected by news, we already have a basis of familiarity. It becomes much easier then to add the news momentum to the equation and come up with rough targets. It is particularly useful to know how the stock has recently been behaving, in the current market, so we look more closely at the action over the previous five days.
On June 22, RIMM announced after the bell that the US patent office had struck down 2 more patents held by NTP Inc., which could be helpful in RIMM's legal battle with NTP. So on June 23, RIMM was running on news momentum, and opened up with a 1.54 gap. That day it pulled back 44 cents from the opening price before bouncing 2.15 dollars. The intra-day range was 4.04 dollars.
On June 24, RIMM had no significant news and closed with an average intra-day range of 2.07 dollars. On June 27, 28, and 29, there was also no significant news momentum and the intra-day ranges were 2.49 dollars, 2.32 dollars, and 2.34 dollars respectively. Those are very similar ranges on non-news days. Even on a fairly flat day, you can usually catch a one dollar bounce off the bottom on RIMM.
On June 29 RIMM closed at 75.91. After hours they reported earnings and were hit with a negative reaction, bringing the stock down to as low as 69.80. The first reactions are quite often the strongest, so its really helpful to watch the knee-jerk action right after news hits. If you are planning to trade a news stock the following morning after the news, it is often helpful to have watched how it traded after hours when the news hit. You want to know where it gradually found support, and how strong that support was. RIMM opened up on June 30 at 72.20, over two dollars above the after hours low. So that was our first clue that bargain hunters were interested in picking up bottoms.
Another thing to keep in mind was the recent pattern on weak stocks. Weak stocks have had good early pops recently, and that’s important to know if you are going to trade dumpers. Apple Computer (AAPL:Nasdaq) was a good example of this on June 3. You might also remember me mentioning our play on Guidant Corp (GDT:NYSE) last Friday. Its important to track the markets reactions to news.
It was also worth noting that the news bringing RIMM down was not really that bad. There was nothing fatal there to prevent short-term recovery of the gap. They beat Q1 expectations. However, its important to concentrate on the tape and remember that its not the news itself that moves a stock, but rather the market’s reaction to that news. One of the most common mistakes traders make is trying to front-run what they think should happen, instead of following the trend they see.
Pre-market on June 30, the price held pretty well around 72. There were no signs of increasing nervousness or an impulse to sell down. The next thing to factor in was the market itself. It is always best to go in the direction of the tide. Nasdaq futures were +6.00, so the environment was generally conducive to buying.
When buyers do come in, they like to buy popular stocks that they perceive as having value. News creates perceived value, whether its good news or bad news. Bad news creates bargain hunting opportunities, and good news creates perceived upward value – at least in the very short term. News creates momentum. So even though RIMM had positive news momentum on June 23, and negative news momentum on June 30, we could anticipate similar early reactions.
This led me to look for about a 50 cent first pullback, followed by a 2.50 dollar bounce. RIMM opened on June 30 at 72.20. It then pulled back to 71.41, where we went long, and that put my upside target roughly around 74. The intra-day range was then 4.05 on June 30, only a penny more than on June 23. The intra-day ranges on the news momentum days were quite similar.
So now you know how I came up with that target. No, it was not exactly a wild guess. It’s a result of a lot of tracking, factoring in the previous reactions and patterns, and observing the current market conditions.