We are in the heart of earnings season and as short term traders this is where the majority of our attention is focused. But on Friday July 29th there was a major fundamental catalyst in MCRB. Its FDA drug trial had failed. The stock was trading lower more than 50%. By 8AM before the market had opened it had already traded more shares than it does in an average day.
When I am evaluating potential trading opportunities each morning one of my top criteria are “pre-market” trading volume. We use SMB Scanner to sort for this. MCRB was #1 on the Scanner. It was trading around $8 down from $35. Visually it reminded me of SRPT from several months ago. These were my written comment from our Game Plan.
The thing that should jump out at you are the “??” where I normally write potential resistance levels. There were none. When SRPT had a similar gap a few months ago it traded back into the teens very quickly. Why would a stock with awful news trade up so much?
A few things to consider:
- There are very few shares outstanding. Which means that if enough traders buy the dip it can trade up to levels where short sellers believe their risk isn’t great
- When a small biotech drops to a low enough price it becomes a game of “hot potato”. The float will turn over many times on the same day with traders competing against each other until the stock finds a longer term equilibrium
- If there is a large short interest when a negative event occurs many of these shorts will use it as an opportunity to cover their shares
- If the stock is down far enough those who are long may not be willing to sell for psychological or emotional reasons creating a “vacuum” until the stock trades up to a price where holders are more likely to sell and accept their losses
Regardless of the reasons behind the large bounces that occur we know that they happen. And so it is our job to identify the price action that makes them more likely to occur. This brings me to the title of the blog post.
The trading idea discussed in our AM Meeting was to buy MCRB after the Open if it dipped near $8. This was an area where it had traded significant volume in the pre-market and bounced.
So when MCRB dropped to 8.10 my price alert triggered and I entered a bid. I was executed immediately. My initial thought was “this isn’t going to work”. I was prepared to get out of the position below 7.80. But then in the next few minutes the stock quickly traded back to 8.50 then 8.80. I said to the trader to my right “You don’t make money this easily in the market. If we are able to quickly make a profit by buying at 8 the stock is likely to trade much higher“.
The point I was making bore out over the next several hours as MCRB traded to 10 and eventually above 12. As a general rule if trades you enter start to work quickly in your favor be mentally prepared to press your trade. Your thesis has turned out to be correct. It has been confirmed by the price action. So the next step is to find a low risk area to press your bet.
For intra-day trading the lowest risk way to press a trade is in a tight horizontal consolidation. That is what the stock did between 10:30-11:00AM. As it broke out of that consolidation on heavy volume as a trader your confidence increases that the stock will see 10. Over the next hour the stock went “vertical” with a “blow off top” above 12.
On a personal note I under performed on the trade. I was long from the low of the day and got flat around 10. As a reminder we discuss the best risk/reward trades each morning in our pre-market meeting. And you have access to our real time positions and audio chat while we trade the setups during the day.
Steven Spencer is the co-founder of SMB Capital and SMB University which provides trading education in stocks, and options. He has traded professionally for 20 years. His email address is: [email protected].
No relevant position