11/10/17 – It’s earning season and one of our more aggressive plays is to take breakout trades above pre-market highs.
On the daily chart below, WTW had earnings and gapped up, making new highs.
On the 5 min chart below, we can see the pre-market high was $51.50. A common question I receive is, “On breakout trades, how does a trader determine the risk for the trade, so that a trader can properly size the position?” One way to determine where to put the stop is to look at the lowest point of the day, which includes the pre-market data. Unfortunately, we can see that if we use this method on this breakout trade, then the stop would give us a risk of over $2.25 ($51.5 – $49.25), which is too much for a $50 priced stock.
If the first method doesn’t provide a trader with a good stop level, then I will use the 1 min or 3 min bar that traded above the pre-market high. On the 1 min chart below, we can see the low of the bar that traded above $51.50 was $50.53. Therefore, with an entry right above $51.5 and a low of $50.5, that provides about a $1 risk level, which means our target to achieve a 2:1 reward:risk level would be $53.5. The reason why I will use the low of the bar as a stop level, even if it isn’t the low of the day, is because if a stock is going to break out, then it should make consecutive higher lows and higher highs for a breakout to the upside. Therefore, the stock wouldn’t trade below the low of the entry bar over the next couple of minutes. As we can see on the 1 minute chart, the stock price reached about $53.49 in about 6 minutes after prices broke out above the pre-market high. In addition, prices never traded near the stop level of $50.5 within 30 minutes of breaking the pre-market high.