I am sure you have heard the terms “Buying Dips” and “Selling Rallies”, but what I would like to do in this short tutorial is explain the exact science that I use to do what sounds like a simple task.
I follow rules and processes when I trade which I have outlined in this document and I do this type of analytical process with each trade I place even if I do this on the fly, these are the things I think about before, during and after each trade.
I provide a simple over view of what we want to do, I outline some questions and then provide the answers. This is my usual style of outlining a strategy or an edge and then I paper trade the idea and I suggest as a trader you should take everything I say here with a pinch of salt, adapt it, own it and make it yours. As with any strategy your belief in its validity and the mental strength required to follow the plan through is a huge part of its success.
Faith will usually only come from trial and error and the pursuit to find truth in any teaching. If you can master this strategy and your own mind you can make great returns and watch your account grow, if you can’t you will watch your account dwindle and the you will continue your quest for the holy grail and I promise you will never find it.
Buying dips – The strategy outlined
This strategy works on all asset classes but my personal preference is with stocks. To increase my probability I prefer to use this strategy during a long term bull market. The idea is to enter a position once an uptrend has already been established with the aim of getting into a move after a period of price retracement. Then exit once we have a small section of the move, we are not trying to catch the entire move. We will get in with a low risk entry and then allow the move to continue, we exit once the move looks as if it is stalling or coming to an end.
What time frames does this strategy work with?
I prefer longer time frames such as weekly or daily, you can make some great profits spread betting this strategy if you do not have the trading capital required to trade stocks with your broker, you can also use a share dealing account as the longer time frame will work really well.
Where is my edge?
We are moving in synergy with the underlying market, sector and stock. We are waiting for a dip so we can enter at a good price and get a good risk to reward ratio of 1:1.5 as a minimum. If we are wrong we will have lost a set amount of funds but if we are right the potential win could be two, three, four times our initial risk or more.
Pre trade market analysis
Before we enter into a trade there are several questions we must answer before we risk any of our trading capital. Below is a list of questions which much answer to true. Once we have a “Yes” to all of the below questions then we can think about placing the trade.
- Is the overall market trending upwards? (e.g. S&P500)
- Is the market sector trending upwards? (e.g. Technology Sector)
- Is the stock or asset trending upwards? (e.g. AAPL)
- Has the stock or asset recently dipped?
- Does the dip in the asset appear to of come to an end, has the short term downtrend completed?
- Where will we place our stop loss?
- Does the previous high prior to the dip provide enough of a move assuming a minimum Risk/Reward ratio of 1:1.5 based on our stop loss price?
- Can we afford the stop loss risk while only risking a small amount of our total capital?
Further food for thought
The above set of questions is really the minimum analysis that I do before placing a trade. We should also have several other questions in our minds, you may wish to do this further analysis, for example:
- What is happening at the given company?
- What is happening around the world?
- What is happening with the company’s competitors?
- What is happening to the underlying currency being used to purchase the stock?
- Is this a short term dip or is the asset about to fall through the floor?
- What other trades am I currently in, does this trade add diversification to my portfolio or am I doubling up in the same sector or market?
- If the stock market crashes tomorrow how much would I loose in all my active trades?
- If the asset spikes in my favour where will I exit?
- How much of my capital is currently invested?
Placing the trade
Determining if a market / sector / asset is moving up or down
We use our eyes and ears to determine if a market or sector is moving up, we can also use an index or ETF relative to what we are trading. For example the S&P500 and Apple. How do we define going up or down, the TiG VMA is the best indicator for determining if a market is moving higher or lower.
Determining if a market has dipped
Quite simply the TiG VMA will turn red for a period of time and we will see the market begin to retrace. At this point I like to draw a Fibonacci retracement on my chart often we will see a 50% retracement as the end of the Dip.
Determining the end of a short term move / dip
We must examine our trading indicators, we can also look at candle price action. An oversold signal on the TiG Value Chart of -8 or more followed by a high, higher than the two previous highs, the TiG VMA will turn blue and start moving to the upside signaling the return of the uptrend and the end of the downtrend.
Determining where to place our stop
I like to examine the last 2-3 candles. You can also use the TiG Trailing Stop. Look at the previous candles low and also make sure you check left for previous support areas, often using previous support is a good way of placing a stop. If there is very strong support slightly lower than your current stop price, consider using this support area.
A tip for a better entry price
You may wish to try and wait for a better price if the moved has spiked upwards. Often you can get a 40-50% retracement on the current candle.
Determining if the move is stalling or ended
The TiG VMA and the TiG Value Chart will both indicate potential reversals and the end of the upwards move, also your stop loss may get hit. If the move starts to stall I like to move my stop even closer, often using the previous candles low. It’s Important to lock in profits, at this point in time you may even want to take half of the position off the table.
Rules of Engagement (ROE)
I have outlined a quick list here for you to refer to as a reminder of your plan of action, keeping a trading journal and documenting your trades is a great way of monitoring your progress.
Rules of engagement during the trade
- Do your ‘Market Analysis’.
- Define your stop-loss and record the information in your trading journal. (STOP @ 93.45 – Risk £500). Set a stop first and then examine the chart to see if the potential for a good risk/reward ratio exists.
- Make a note of the total risk reward ratio using the previous high before the dip. (R/R 1:3.6).
- Is the TiG Value Chart showing signs of oversold?
- Can you get a better price?
- Can you afford the trade, risking a small amount of your account?
- Examine the current closed candle to see if the downtrend is stalling, has the high of the current candle broken the high of the previous 2 fully formed candles. Has the TiG VMA turned blue suggesting the end of the dip showing that price is now moving back in the direction of the larger trend?
Rules of engagement during the trade
- Monitor your position at the end of each formed candle, it is important to review the closed candle data.
- You may wish to move your stop-loss closer if the move appears to be stalling or reversing. Overbought signals such as an overbought TiG Value Chart reading of +8 or +12 or a change of colour on the TiG VMA could mean the move is about to reverse into your stop, consider moving your stop closer.
- Never ever move your stop lower to allow more risk. Your stop may trail upwards only.
- Use your eyes and ears to monitor the market and sector for signs of a change in overall trend.
- Relax, enjoy watching the move unfold. Follow the Rules of Engagement to stay in the trade.
Rules of engagement after the trade
- Review the trade.
- Did you follow the Rules of Engagement?
- Where you correct in your initial analysis?
- Could you of done more to protect your capital and profits?
- Remember that being stopped out is part of the game, you may get stopped out multiple times in a row. If you have been stopped out should you re-enter the trade, were you too eager initially?
Follow your rules of engagement and take your profits
Follow your plan and trade it as you planned it, don’t let greed or fear overcome you, if you have made a great trade, take the profits when they are good do not hang on longer than need be. At the time of writing this document many people are struggling to get 3% per year on their investments. If my position is up more than 20% in less than 1 year I may well take a large portion of the table. Take your hard work and bank it with a smile.
Your goal is to grow your account and you only have a have a set amount of funds in your account. The goal with trading is to protect the money you have first and then add to it second.
You should be trying to talk yourself out of a trade, not trying to talk yourself into one. Look for reasons to not place the trade. You are looking for low risk opportunities to grow your account size larger. You are not looking simply for trades to place, you can place trades all day long and watch the account shrink before your eyes. This is not a game, this is not something you should rush. If you had £10,000 free to invest in a real business opportunity you would not just jump straight into the first business that asked you for the money.
You would research long and hard and ponder the possible outcomes. Many retail investors will actually spend more time researching the best new television on the market, they will spend days or even weeks reading reviews and trying to get a discount or better price, the television may be only £2000, but this same person will pick a stock at random and drop £5000 into a dead end stock then watch the asset shrink.
Remember if you are trading stocks you are actually placing your money into a real company, it often amazes me how people seem to forget this.
I am not going to spend too much time to explain selling rallies, once you have mastered buying a dip, flip the logic upside down and you can use these teachings to sell a rally, my personal preference is to buy stocks, I tend to buy the dips more than I sell rallies. But if short selling is your thing I am sure you can understand the logic from above to do so.
I hope you have enjoyed reading this document, I hope it serves you well. I very much enjoy the markets and the people who take risks playing in them, it’s a fantastic game and I wish you the very best of luck.