Looking for a way to trade this market? Try this bounce trade method. (May 14, 2019)

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Let’s talk about what I call bounce trades. They are not the super deep oversold snapbacks that I look at with really, really wide Bollinger Bands where a stock does this; Intuitive Surgical ( NASDAQ: ISRG ), falls way down here, gets so oversold and then finally moves up the other side and gives you a nice trade that way. I am talking about these types of trades where it starts at overbought and then falls back to find prior support. These are just what I call bounce trades.

If we want to look at them in the type of construct that I look at volatility squeezes, which it doesn’t have to be volatility squeezes it can be just kind of like any move in stocks. They tend to follow these three phases, where you will get some kind of consolidation, some kind of congestion. Phase 1 is the initial break out. Phase 2 is a pullback to actually test that breakout level and see if it holds, see if it is valid. And then Phase 3 hopefully is the proposed rally and up to new highs. So it’s like you get this breakout, a pullback and then a bounce play where the stock continues to move.

The thing is, the real key to this is looking at where support lies. Here we have got to say support is right around this level. And the reason we say that is because that level used to be resistance. And so the stock breaks through, comes back and tests the prior ceiling to see if it is a floor. So if you are timing this thing correctly you can manage your risk by keeping a pretty tight stop here, you don’t have to put it clear down here. You’re taking a bounce trade. You are trading that transition from the Phase 2 pullback to the Phase 3 bounce.

Now, we don’t know whether this is going to continue to go higher here, that’s not the trade. The trade is the idea that at least we have the stock that has pulled back to an identifiable support level, which allows us to define our risk. The definition of risk, in this case, is pretty good because we can keep the stop pretty tight. And then as far as the reward we just get what we get. Sometimes the stock will really just do this, and then other times it will just kind of fart around here. But you are typically going to get a few percent, anyway, on this rebound.

If we look at GW Pharma ( NASDAQ: GWPH ) you can see that yesterday, Monday, was the low here, 172.50. and now we are getting a little move to the upside today. So you can make this trade tomorrow, frankly, give it like a 3 percent stop. I would not be holding the stock if it fell back below today’s intraday low. I don’t care about this. I don’t care about the 50-day moving average. What I care about is my strategy, my methodology, which is overbought, steep pull back and identification of support, which is logical here, and then an ability to place a really tight stop and enjoy an upside here. So that is really the trade here on GW Pharmaceuticals ( NASDAQ: GWPH ), it is just a simple bounce trade.

We can look at a couple of others; Carvana ( NYSE: CVNA ), the same thing. I am not looking at this as a stock that is going to run up through 75.00 and march on to victory up to $100.00. I am just looking at this as a stock that is probably not going to fall here. You set your stop, again, just below today’s intraday low or perhaps even yesterday’s. Frankly, there is an argument to be made that you could even put it here at 64.00. Keep a really tight stop on a trade like this because your whole thesis for the trade is you’re trading a bounce. So if the stock doesn’t move up, instead it starts rolling over again, well, you don’t want to be long because that is not a bounce, that’s a trounce and that isn’t going to work well.

One last one that you can look at, frankly, is Lululemon ( NASDAQ: LULU ), where it gives you the same type of thing. It wasn’t really overbought but you can see where the stock had broken through resistance here at about 160.00. It rallied up and then it created a new floor at about 165.00, and now the stock has fallen back to that same floor at 165.00. Now you are looking at this stock here and you say, “I don’t know how much I am going to get but I know how much I am going to risk. I am going to risk about 3 percent here and then I will get what I get. I will manage the trade as it works in my favor.”

These are, again, what I call bounce trades; they are bouncing off the floor, what used to be the ceiling. Reward unknown, but the risk is definitely known and definitely defined. I hope this type of strategy works for you.

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