Tradytics AI | February 5th, 2022
Most people treat trading like gambling and go into plays without any proper plan or due diligence. This could be one of the reasons most traders lose money, especially new ones. It is also quite common for new traders to wipe out their entire first account before learning principles of risk management, position sizing, technical analysis etc. This series aims at filling a few gaps with beginner traders by introducing simple yet effective strategies, and most importantly talking about how they can also fail. It will be a multi-part series on what trading strategies can beginner-intermediate traders use to trade better. The three strategies that we are going to discuss in this first part are:
Inside days is one of the simplest plays beginner traders can learn, yet it is very effective if used right. Inside days are days where the candle of the day stays completely inside yesterday's candle. Inside days signify a decrease in the volatility. Generally, in the markets, volatility decrease periods are followed by volatility expansion i.e large moves.
Generally, in the markets, volatility decrease periods are followed by volatility expansion i.e large moves.
Inside days work well because once volatility contracts, the next candle sometimes makes a large move which gives us a good reward and risk.
Now that we know the reasoning behind playing inside days, let us talk about how to play them. Basically, we play an inside day when the next candle to the inside candle breaks the high or low of the inside candle. Assume we had an inside day yesterday, our play for today would be to wait until today's candle breaks either the low or the high of yesterday's inside candle, and then enter. Our exit (profit taking) would be the high (in case of bullish setup) or low (in case of a bearish setup) of the candle prior to the inside candle.
The image above demonstrates a wonderful play in DISCA that we at Tradytics took. On January 27, 2022, DISCA had an inside day candle after a large red outside/engulfing candle on January 26th. Therefore, our play on January 28th was to wait until we break the high or low of the inside candle. Once we did break to the upside, we entered in the circular area and rode calls all the way to the high of the day. As you can see, inside days are incredibly simple to play and can be very profitable. The devil is obviously in the details and we will discuss some tips and tricks next. Please note that inside days can be played to both up and downside depending on whether they break the high or low of the inside candle. Therefore, when playing these, please keep your mind open and don't have a particular bullish or bearish thesis. Play what you see.
It is easy to learn these strategies, but once you start playing them, you see many nuances. These tips and tricks sections are to deal with those and help you get an additional edge based on all the analysis we have done at Tradytics.
You do not have to spend time looking for inside day plays yourself. You can simply go to Scany and use the Inside day filter to search for them. Scany is a comprehensive stock scanner, and you'll find many of the strategies discussed in this series as filters on the tool.
When trying to play inside days, it is better if we have full time frame continuity in the direction we are playing. For instance, if we are breaking to the upside of the inside candle, it adds to our probabilities if the weekly, monthly, and daily change in price have all been green as well. When multiple timeframes face in the same direction, that's what is called a time frame continuity. You will often see that when there is no time frame continuity, the candle will break the high of inside candle and just came back down, causing fake outs.
Generally, if the candle prior to the inside day candle is very large, the plays are better. It is because our profit margins increase when the prior candle is large as we now have a large price range to cover to reach our target. There's also a filter called "Outside Inside Day" in Scany that you can use.
Double inside days indicate two candles that go inside of the last candle. This happens rarely but whenever there's a double inside day play, the probability of a large move increases. This happens because remember, when volatility contracts, it usually expands afterwards. You can find double inside days in Scany as well.
Lotto Fridays is a term common among day traders. It refers to increased volatility on Fridays and playing 0 days till expiration options plays. Inside days are a great way to create your lotto Friday plays.
Gap and go is a swing strategy that can often yield low accuracy, but very high profits. It works because often times, when price gaps up or down, and continues going in the gap direction, that can signify a fundamental change. This can be an amazing earnings report, an acquisition, or any important event in the company. If the outlook of the company changes significantly from a fundamental perspective, and price continues in the gapped direction, that can lead to long rallies and large profits.
Gap and go is played by waiting for a gap, and a confirmation candle after the gap candle. For instance, if we gap up, and candle following the gap up also goes up nicely, that candle provides us confirmation that the gap up is legitimate, and can therefore be the start of a new rally. An entry on the close of the confirmation candle is a great way to play these setups.
When talking about gap and go strategy, UPST is the first stock that comes to mind over the last year. It did not just have one gap & go, it had three high profit plays simply based on this strategy. On March 18 and August 11, 2021, we had gap ups in the price following earnings report. After the initial gap, the second candle also closed green which gave us the confirmation that traders are confident in the gap. An entry on the second/confirmation candle would have given us max profits of 46% and 118%. Realistically, since we cannot always time the top and bottom, a simple exit once we break the 20 moving average would have given us 20% and 74% profits, which is still a huge number.
Finally, the third time we had a gap and go on November 10th, 2021, where we gapped down after earnings and continued all the way down from 240 to 100, which is more than a 100% profit per trade. These three trades illustrate how effective this strategy can be.
Gap and go strategy is highly profitable, but has a low accuracy rate since many gap & go plays end up reversing immediately. However, because of how profitable valid plays can be, you only need a few valid plays to make up for all your losses. Here are some tricks to play these.
Similar to inside days, you do not have to manually find these plays. You can simply go to Scany and use the Gap & Go filter to search for them.
We have talked about when to enter, but when to exit. When a trend starts after a gap up or down, it is generally a great idea to follow any trend following indicator, such as moving averages. A simple 20 exponential moving average can be a great way to stay in a trade, and exit once the price breaks it to the opposite side. Sometimes, price might actually cause a fake out, and immediately reverse and go above or below a gap down and respectively. In that case, we can simply close the position and take a small loss.
VCP pattern is a bullish strategy and was developed by Mark Minervini, who is a famous technical analyst and an acclaimed breakout trader. The reasoning behind why VCP works is very similar to why inside days work. When volatility contracts, it ends up expanding, and providing good reward and risk. What the VCP pattern adds on top is a large number of very effective filters and criteria to leave us with the very best possible plays.
There are a couple of steps in the formation and playing of a VCP Pattern.
First, we usually want the stock to be in a strong uptrend and have solid fundamentals such as revenue, profits, earnings, etc.
Second, we want the stock to go into a volatility contraction phase where price starts to move in a very confined region with low volume. We want the contraction phase to happen after an uptrend.
Finally, we want the price to break out from the contraction phase. The breakout could either be just a technical breakout, or being caused by a fundamental event such as good earnings. Once we get the breakout, we enter into the play.
The figure above shows a VCP pattern for AAPL. Price went up for a few months before retracing a bit and starting to contract in volatility. During the contraction phase volume remained low. Finally, price broke out of the contraction region with a large green candle, which was the entry here. Similar to how we can set a trailing stoploss using the 20 moving average, we can do it here as well and leave the play. This lets us ride the profits all the way to the top before the trend breaks.
We have not talked about crypto, so let's take an example from there as well. The image above shows the weekly chart of Bitcoin (BTC) and a great example of how VCP pattern can provide great entries, and huge profits. From March 2020 to September 2022, BTC had a good run from 5k to 10k, which was followed by a contraction in the price movement i.e volatility. Eventually in October, we broke out of the VCP pattern and price went from 10k to 40k in just a few months. Obviously this is a cherry picked example. However, just the fact that a single trade based on a simple pattern gave about 200-300% profits is a good reason to learn & use this.
Finding VCP setups is sometimes non-trivial because of how many stages are involved in it. You can use Scany to find volatility contraction setups but that's just one part of the entire pattern. Some manual effort is required here to make sure all conditions are met. However, since this is basically a breakout strategy, all tips that work with a breakout should work here as well.
A very easy way to take profits and exit with these setups is to use the 20 or even 9 moving average as a trailing stoploss. We remain in the position as long as the price stays above the moving average, and exit once we break it.
The largest uptrends after the volatility contraction happen when the fundamentals are great. If there are great earnings report, and we have a VCP setup, that's much better than a company with bad earnings & fundamentals.
That is it for this guide. This is just the first guide in a series on Trading Strategies, and we will continue adding more guides in the future. We hope you learn something, and this helps improve your trading. As always, please always manager your risk, stay safe, put in hard work, and you'll only get better. Thank you for reading.