Chapter 6-1 Buying and Shorting Through the Figure
Buying and shorting stocks through figures (example: $49.00) is one of the most common trading setups. The reason is simple. Support and resistance levels are most often found at figures. Furthermore, support and resistance levels typically provide numerous potentially profitable setups. The most popular of the setups is buying and shorting through figures. Therefore, it is imperative to understand the fundamentals of the setup and the many different ways in which the trade can transpire.
There are three typical scenarios that occur when a stock is breaking through a figure. A keen trader can decipher which of the three scenarios is most likely going to take place by watching the prints of the tape. We will use the following example to explain the difference between the three scenarios.
A stock is trading in a strong upward pattern approaching $37.00 for the first time today and is currently trading at $36.95. There is size of 15,000 shares limited at $37.00 (the figure) on the NYSE limit book. This is a relatively large limit order for the stock as its average daily volume is only one million shares a day and it is on pace to do that today. Furthermore, the limit order is by far the largest order on the NYSE book within 15 cents up or down of the current quote price. You have determined that $37.00, due to the large size limited at it, will be a resistance level and if the stock can break through that level the stock will move much higher. With this example in place, one of the following three scenarios will most likely occur.
One, the stock approaches the level at $37.00, shows great strength by printing the 15,000 shares relatively quickly and in block prints (prints of more than 1,000 shares at a time) clearing the size off the NYSE limit book, then makes a print of $37.01 or higher on the tape. This sends a buy signal to traders that the stock is strong and will most likely go higher than the current price. Moreover, those that were short this stock anticipating that the large size limited at $37.00 would remain and create an impenetrable resistance are forced to quickly cover their positions manually or via stop orders, buying back the stock for losses at whatever price they can get. As a result, the combination of frantic short covering, along with new buyers entering due to the breakout, create a wave of buying pressure flooding the stock with buy orders, catapulting the stock to new highs on the day. This is typically the most favorable scenario as it is regularly the quickest and easiest to recognize. This scenario occurs more often on days when market volatility is extremely high.
Two, the stock approaches the level at $37.00 and prints all of the 15,000 shares, but all of which (or most of which) were small prints (prints of less than 1,000 shares). As a result, even if the stock does manage to print $37.01 or higher, there is no real conviction. This creates a big problem as the stock has many smaller traders in the position, all at the same entry price. Even if the stock starts to print higher, the second someone sells their position and creates a downtick on the tape, it will cause a domino effect sending the stock downward sharply. But just as the stock went up with no real conviction, it is going down with no real conviction. Thus, the stock will most likely settle near its previous support level, wherever it may be, and make another attempt later on in the day at breaking through the level. This scenario gives new traders the most trouble. Simply because the trade begins to work in their direction, but suddenly fails turning a winning trade into a losing trade. This scenario occurs most often when the stock market is stagnant and choppy, meaning the market is in a repeated pattern in which it makes a move then abruptly stops.
Three, the stock approaches $37.00, fails to print through all of the 15,000 shares on the NYSE limit book, and then reverses trend. This occurs because the stock does not have enough momentum to penetrate through the level at the figure, which ultimately sends a reverse signal to traders who then look to short. Moreover, all those who went long in anticipation of the stock breaking through the resistance or were already long from a much lower price are now forced to sell as they lose confidence in the strength of the stock. As a result, the combination of buyers exiting, along with new shorts entering positions, creates heavy downward pressure on the stock. As the stock drops further away from the figure, the downward pressure increases turning the up trending stock chart into a down trending one. This scenario can occur in both volatile and stagnant markets.
The three scenarios were shown with an example of buying through figures on up trending charts; however, they also occur just like they were described above for shorts through figures on down trending stocks through support. Watching the prints is the key with all three of these scenarios whether buying or shorting through figures. The prints will allow you to predict which scenario is most likely going to occur. Though like with all trading there is no guarantee, putting yourself in high probability trades with little risk time and time again will produce consistency and success.