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Stock Downside Trade and Breakdown

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  • Downside Trade Indicators
  • Downside Trade Tips
  • A trading system based on high profit/loss ratios and diversification
  • Breakdown Trade
  • Breakdown Trade Tips
Disclaimer: This is NOT investment advice, just general help and opinions, please check with a registered investment advisor before making any investment decisions. This document may contain errors. Chapman Advisory Group LLC employees are not investment advisors. Please review:
Downside Trade Indicators
  • Provide downside trade information to gauge the quality and profit for short term short trades(3 days to 6 weeks).
    Downside IndicatorInformation
    Trade Quality
    • An indicator that analyzes Target 1 profit, potential and profit/loss ratio.
    • Good Trade Quality means there is good target 1 profit and potential along with a high profit/loss ratio (a tight cover limit is available).
    Target 1
    • Target 1 is a stock price that a typical short term pullback may achieve.
    • These typical pullbacks can last anywhere from 3 days to 6 weeks in duration and occur approximately 6 to 12 times a year.
    • The Target 1 percent profit is also listed.
    Cover Limit
    • The cover limit price is provided along with the percent loss from the current stock price.
    • A cover limit is either a mental or automatic (placed with a broker) sell order placed above the current stock price to limit loss.
    • Cover limits are only adjusted in one direction (down) and trails above the current stock price.
    Profit/Loss Ratio
    • The Profit/loss Ratio indicator is the ratio of Target 1 profit divided by the cover limit loss.
    • Higher profit/loss ratios above 2.5:1 signify higher quality trades.
    Target 1 Potential
    • Analyzes support areas that block the pullback to Target 1 and helps the investor gauge if Target 1 is possible.
    • It may be unreasonable to expect a stock to reach the Target price (low potential) if blocked by one or more strong double or triple support areas.
    Target 1 Support
    • Lists the support areas between the current stock price and Target 1.
    Target 2
    • Target 2 is a stock price which may reached on an extreme pullback which occurs only 5% of the time or approximately 1-2 times every 6 months.
    • A stock rarely remains at Target 2, some investors may want to cover at Target 2 to lock in good short term profits.
Downside Trade Tips
  • Cover limits can be used as a tool to lock in profit when adjusted daily to trail the stock price as it moves lower. This removes the decision on "When do I cover?" while maximizing short term profit.
  • The Target 1 potential drops significantly when strong double or triple support areas exist midway between the current stock price and Target 1.
  • The Targets 1 and 2 may be exceeded on very strong pullbacks that occur over a short time frame. On slow down trending stocks the Target's 1 and 2 will track lower with the trend.
  • Cover limits are typically left loose upon going short at the start of a pullback, then as the pullback progresses the cover limits are tightened. If the stock reaches Target 2 (extreme pullback and/or extremely oversold) one should set a very tight cover limit to lock in short term profit.
  • Beware of temporary gaps up in the morning from triggering your cover limit and stealing your shares.
  • Cover limits should be tightened after 3 days of flat stock price movement.
    If a stock has a good pullback but then is flat for 3 days then one should be able to tighten the cover limit. If after 3 days no attempt has been made to move lower then a support area will have formed and the stock may be in danger of rallying at that time. At this point two possibilities exist: it will move lower and you will profit from a future pullback or you will lock in good profits on any strength. This also can be applied to shorting stocks on a rally to resistance. If after 3 days no weakness is seen then the stock may be in danger of continuing upward and tightening the cover limit will lower losses.
A trading system based on high profit/loss ratios and diversification
  • A powerful trading system can be developed based on trades with high profit/loss ratio's of at least 3:1 and diversification into 8 to 12 positions.
  • This combination of diversification and high profit/loss ratio's may mean that overall you have to correct only 33% of the time to breakeven. This is based on a typical 15% profit, 3:1 profit/loss ratio, 5% stop limits, and diversification into 10 positions with a constant $ loss (see note below).
  • Finding stocks with even better profit/loss ratio's, and being more aggressive on stop limits by adjusting them to at least breakeven once a stock moves may mean overall you have to be correct only 16% of the time to break even.
  • With such a robust trading system (solid foundation) the house becomes stacked in your favor and your long term profits rely less on the accuracy of your trading picks and more lenient on trading mistakes.
  • To keep a constant dollar loss amount over all your 8 to 12 positions set the base loss % and trade amount in the Downside Recalc tool and to calculate the risk trade amount and number of shares.
Breakdown Trade
  • Breakdowns are quick pullbacks that occur when a stock breaks through a support area. Typically the next support will be a good distance away (or a new low area) giving the stock room to pullback.
  • A stock usually starts to pullback and breakdown once it moves below a trigger price. This trigger price is typically close to the lower edge of the current support area.
  • Upon breakdown stock can be expected to reach the breakdown target price. Also listed is the cover limit and profit/loss ratio for the breakdown.
  • Breakdowns vary in how quickly they pullback and reach the breakdown target.
    • True Breakdowns are the strongest breakdowns made from type double or higher support areas and their pullbacks typically last only 3 to 5 days.
    • Continuation Breakdowns are made from type single support areas and their pullbacks typically last longer at 1 to 3 weeks.
  • Breakdowns fall into three categories depending on their state:
    • WATCH: A watch breakdown is currently stuck at support and may breakdown.
    • CONFIRMED: A confirmed breakdown is a stock that has started to breakdown and is below it's trigger price and support area.
    • POSSIBLE: A possible breakdown is a stock which has started to breakdown(below it's trigger price and support area) but has a mixed possibility of continuing lower(no bearish backing).
Breakdown Trade Tips
  • Profit/loss ratios are higher (higher profit potential with tighter cover limits) on Watch Breakdown types but they have yet to pullback. If one can look at the 3 and 5 day intraday chart one may be able to observe distribution and enter a position in anticipation of a confirmed breakdown. If one does enter a position in anticipation of a breakdown and a few days go by without one occuring one should tighten the cover limit to protect against a rally.
  • Confirmed breakdowns typically have lower profit/loss ratios (lower profit potential with looser cover limits) but may have a higher probability of continuing lower. One may help prevent false breakdowns by looking for strong selling volume on the 3 or 5 day intraday chart (and strong bearish 1 day Moneyflow) during the start of the breakdown.
  • Beware of breakdowns with only one day of high volume followed by days of low volume (no follow through). If this occurs tighten the cover limit to lower loss for a possible false breakdown.
  • Stocks that are oversold may go even lower on a breakdown.
  • Screening for Confirmed breakdowns and looking at the type of stocks (and their sectors/industry groups) can reveal where the current weakness and money is leaving. Looking at which stocks are down on a up market day can also provide some insight.
  • The end of a Breakdown pullback (bottom) may occur on a day with high volume(high 1 day Moneyflow) but flat price movement.
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