Ten days ago, we wrote about a stock we thought was going higher based on its breakout from 11 weeks of consolidation. We were wrong. And we like it. At 360 Investment Research, we aren’t concerned about being right. We’re concerned about being on the right side of the trade. In this instance, our methodology was solid:
- Price was breaking out to new highs
- The breakout was occurring after 11 weeks of sideways price action
- The sideways consolidation took place after a large cup consolidation
- All the aforementioned was taking place within a well-defined weekly uptrend
- We could identify when we were wrong (stops of 47.50 and 47.00)
- We had a target based on the pattern (55.00) that held an asymmetric risk/reward ratio
With the aforementioned parameters, we would make that trade again and still could (more on that in a bit). In this case, we were stopped out at 47.50, which eliminated our exposure to the 5 day, 5% drop in price. Such an event will school you quickly on investment psychology. Our risk management was solid.
So what happened? Why didn’t our higher probability scenario of more new highs play out? Simple. Buyers disappeared. Price discovery (the determination of price) is rooted in the simple economic law of supply and demand. More demand than supply, the price goes up. More supply than demand, the price goes down. In this particular instance, price rose to new highs and demand disappeared. When breakouts like this one fail, it carries significance and means demand was exhausted. When this happens, price can experience quick downward pressure. Hence the phrase, “from false moves come fast moves.” This was confirmed in PAYX by observing the swift downward price action over five days. With technical analysis helping us identify a proper exit, we were able to avoid this rapid decline. In addition, it should be noted that it also allows us to change our trade to short. Knowing the aforementioned – that a failure of the breakout would likely mean rapid price decline, we’re able to jump on the other side of the trade quickly. A current month, in the money put option (near our exit point), gained over 60% in five days. That is the power of technical analysis – knowing when you’re wrong, which can put you on the right side of the trade.
As for the future plans on PAYX, we like that it held within the green upward price channel and found new buyers near its most logical point of demand (44-44.50). We’ll own it above 48.00. Below that price level, we’re not interested.
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