Why This Bull Flag Strategy Works on IPOs
In the last blog post, I talked about trading SWAV breaking out of a high, tight flag last Friday. I tweeted about SWAV on Stocktwits as it was breaking out.
I sold the final shares near $41 on Monday after getting in after it broke $34.20 to new highs the prior Friday.
In this update I’ll discuss the trading strategy I used to exit and compare it with the conventional ways of determining an exit on a trade like this.
The Conventional Way of Exiting Bull Flags using Candlestick Trading
Now recent IPOs are more volatile to be sure. They often turn over quickly and go far below the IPO price.
So, first of all, I focus on a select few recent IPOs that form a high, tight flag and meet the rules in my trading plan covering the most bullish technical pattern.
This is because many IPOs will drop 50% or more from the IPO price quickly. Others will be overpriced and go lower. Others will go higher. It can be pretty random and not really tied to the real value of the company which is very debatable for an IPO in the first place.
This is why I look for just the strongest technical patterns on the best IPOs within the first few months of trading when trading stocks that have just come to the public market.
The typical way of playing a bull flag breakout is to buy a little above the breakout point and then wait for a bearish candlestick pattern while stopping below the low in the flag. Here are the problems I have found over the years with using this strategy and candlestick patterns for sell signals – especially on recent IPOs like SWAV:
- First of all, a low volume stock and recent IPO like SWAV are more volatile. Volatile stocks just do not have the same amount of algorithms and high frequency traders to catch pullbacks. So they tend to be much more emotional like penny stocks without market participants automatically catching the pullbacks quickly within a strong uptrend.
- So using a candlestick pattern as an exit strategy results in taking more risk. Much more than the strategy taught in the high, tight flag course.
- They are easier to manipulate. Its easier to push the stock lower below support levels where they tend to cause traders to panic and sell with no real new news. So the price has a stronger tendency to go below these levels when testing support. They will often drop 5% to 10% or more below the support before rebounding before the market close. However, I have no interest in ever sitting on a 20%+ loss on a trade and hope that the pullback is just a technical break.
- I have found that using a bearish candlestick pattern does not have a very high success rate. Except in the cases where its a very strong candlestick pattern on higher volume stocks. The pullback in SWAV after we sold on Monday could have been interpreted as a bearish candlestick pattern on a daily chart but probably not.
The move on Wednesday generated a candle very similar to a bearish engulfing candle which was confirmed the next day. Those using candlestick patterns to determine their exit point would probably have sold at that point for a small loss. Especially since the stock pulled back through the entry point.
Meanwhile, the optimized strategy to get out on a parabolic move on Monday taught in the high, tight flag strategy resulted in about a 20% profit in just 1 trading day on most of our initial position put on the trading day prior.
Now if this stock had more volume and been trading for a longer time, there would have been a better chance of a sizable profit while using bearish candlestick patterns to determine your exit in my experience. Low volume is part of the problem.
This is another reason we used the optimized strategy taught in the course to take most of our position off at about a 20% profit while trading with a very tight stop-loss.
Playing it the conventional way using candlestick patterns on a better stock will lead to a few big winners. However, its a very wide stop-loss and a much lower win rate when using that method – especially with recent IPOs like SWAV. We see a much higher win rate and average profit per day when using the rules in our high, tight flag strategy.
Over the next few months we are currently expecting to see a surge of new IPOs coming to market with incredible growth. Companies like Uber, Lyft, Airbnb, Robinhood and a lot of cannabis stocks. Some will just buy them and sit on 20%+ losses in many cases because they use buy-and-hold techniques.
Not for me. I will be looking for the top technical pattern and playing it with a very tight stop-loss, a historically high win rate in my back-testing with huge upside potential in just a few days like SWAV. All while risking very little of my trading capital using the ideal tight stop-loss taught in the course.
So why not hold it and go for just 1 home run? Well, with compounding, just 60 trades at 8% per trade would turn $10,000 into over a $1 million. Buy and hold a few IPOs and your chances of this occurring over the next couple years are slim to none.
Just go to a compound interest calculator tool to verify this. Plug in 8%, 60 and 10k. 8% per year is basically the same as 8% per trade when using the calculator (if you average that over all your winning and losing trades – that’s the challenge). The compounding affect works out about the same – with a tight stop-loss especially.
8% per trade average is a real possibility when playing just high, tight flag breakouts that meet the rules in the course over time while using no margin. But its just not realistic when you ignore the key rules taught in the course. Or if you do not follow a good exit plan. You need the higher win rate and big average profit while using a tight stop-loss.
During a market uptrend we generally find about 3-6 high, tight flags per month that meet all of our important rules at the breakout point. SWAV was a little light on volume but other very strong factors caused us to give it the nod.
Using just this strategy can be a huge time-saver as a trader. Sweating it out to make tiny profits day trading small gaps every day is difficult at best. Plus you have all the work before and after the trading day to improve your results. It takes most traders years to become profitable using those techniques – if they become profitable at all.
I find it a waste of time versus using just the very best swing trading strategies on the best stocks selectively. Think about just limiting yourself to just 4 ideal swing trades per month during most months. This will save you a lot of precious time and produce better results for most traders.
I only trade about 1 in 5 high, tight flag breakouts that come up on my radar. And that is the most bullish technical pattern. Being selective is key. They have to meet key rules in my trading plan at the breakout point.
The high, tight flag strategy is our top method for a real shot at building a small account quickly into a million dollar trading account while keeping your average time in a trade to less than 4 trading days and using a very tight stop-loss. Just 60 ideal trades per year could generate serious profits as outlined above. Even 4% per trade would result in an amazing year.
In my opinion, the best shot is to trade just the most bullish technical setups on the best stocks with some logical reason for the stock to suddenly be worth more to traders and investors. Stocks that meet the criteria in our high, tight flag strategy at the point of entry is a great example of an ideal trade.