This is a modified strategy for the active options trader. When we are buying calls or puts, we want to do so at the lowest levels possible. To help in doing this, we put in limit orders below the previous close or most recent last closing price and let those oversold or overbrought opportunities come to us when making high probability, short term trades in stocks, electronic traded fund, and commodities. We like to have opportunities come to us, rather than chase them.
We are looking to buy the pulled back, our trading strategy is to use limit orders below the previous close or most recent last closing price. This gives us the opportunity for playing pull backs on an intraday basis, giving us an even lower priced entry into the position. It has been a valuable part of our overall approach to buying weakness and selling strength.
We use a 4-day moving average and wait for our stock to close above or below that 4-day moving average. Once it has done so, we exit at the market.
Once we have spotted our oversold stock, we look to use continued strength in the stock as an opportunity to take a position on the short side. This is the intraday strength that we talk about. In the same way that we look for intraday weakness to enter long positions, we look for intraday strength to enter short positions. By putting a sell limit order anywhere from 2% to 6% above the previous close, we allow stocks to "come to us" rather than chasing them. We've found this approach to work as well for buying strong stocks as it does for shorting weak stocks.
There are different options for short term traders following this trading strategy. If you place your limit order very close to the previous close or most recent last closing price, for example at 1-3% below that level, then you are likely to get more fills than if you placed your limit order farther away. This will mean more trades and, relatively speaking a larger number of losing trades, as well.
If you place your limit order at a greater distance from the previous close or most recent last closing price, such as 4-6%, then you will get significantly fewer trades than if your limit order were closer. But those trades will likely be more profitable as you will only be trading the deepest pullbacks and the most oversold stocks, electronic traded fund, and commodities.
Because we look to buy stocks, electronic traded fund, and commodities after they have pulled back rather than after they have broken out to new highs, our approach to entering trades is different from that of many short term trading strategies. This approach does more than just get us into trades at the lowest possible levels. It also serves to keep us disciplined rather than emotional when it comes to taking trades.
If you want to be more active as a trader, use a tighter limit order. If you only want the biggest pullbacks and don't mind missing a few of the more modest gaining trades, then go ahead and use a limit order that is 4% or more below the stocks, electronic traded fund, and commodities previous close or most recent last closing price.
One observation, with the sort of high probability, high win-rate trading opportunities that, the downside of using a tighter limit order that ostensibly increases trade frequency and potential losses is much less pronounced than it might be with other strategies with win rates closer to 50%. This is why having a strict entry rule, such as using limit order 2% to 6% below the stock's last close is so helpful. By the time an already oversold stock makes an additional 2-6% correction intraday, that stock is all more likely to have run out of willing sellers and that is the moment we are waiting for. So when looking to trade stocks, electronic traded fund, and commodities, be sure that you don't chase those trades. Put in your limit order below the previous close and let those oversold opportunities come to you.
Whichever approach you take should be based on your personality and trading preferences.
