When I was a kid, I liked to tinker. I would take things apart just to see how they worked and could not rest until I figured it out. I would take apart toasters, hair dryers and TV sets just to see what made them tick. My only problem was, I was not particularly good at putting them back together again. This, you can imagine, did not make my mom happy at all and I was soon banned from dismantling

any

household appliances.

Who knew that this obsession of mine would end up making me a lot of money later in life as a daytrader? Today I am going to dismantle one of my favorite plays, gainers. The only catch is, you have to put it back together again once I take it apart.

Gainers are stocks that climb greater than 20% (from the previous day's close) on good news and momentum. A good example of a predictable gainer would be a company that reports positive earnings after the bell. There are many variables, but usually the stock rises on anticipation of earnings then gaps up the next day.

I play gainers on the first day after the run-up one of three ways the next morning: I either buy at the first dip, short it at the open or short at first high. I identify the bottom using my "pause-in-betweener-buying" method described in my

Feb. 28 column.

The normal pattern I see for gainers that gap up is to sell off immediately then bounce as traders and investors react to the good news and buy. Weaker stories sell off more at the first dip than stronger stories. A gainer that gaps up on a very strong story will normally either sell off a small bit immediately then bounce or it will take off from the open with little or no dip.

A gainer that gaps up 10% or more on a weak story or a story that does not impact earnings in the near future can be considered for an open short. Remember, not only does the street overreact to bad news, but to good news also. Shorting at the open is a method to take advantage of this overreaction.

To increase my winning percentages, I keep a tracking diary that records how all my patterns are currently reacting. If I note that strong gainers are currently gapping up, selling off immediately then bouncing on the first dip, I then have a rough idea of

what to expect

. This certainly does not guarantee that the pattern will react in this manner, nor is it meant to be a crystal ball, but it does give you some insight into how a pattern is currently reacting a good percentage of the time.

Take a look at the chart on

Software Spectrum

(SSPE)

, a software and technology supplier. On March 10, the stock opened up at 19 1/2, climbed all day long and ended the day at 27 13/32 on news it was strengthening its global alliance with

IBM

(IBM) - Get Report

. The story was interpreted by investors and traders as strong, and it gapped up the following Monday to a little over 28. Notice the dip (point a) where it dropped to 27 1/2, then the climb to 38 7/8 (point b).

American Software

(AMSWA) - Get Report

, a software solution developer, is another good example of a predictable first day gainer that could have been bought at the first dip (point b). On news of a strategic alliance with IBM, it rose and closed a bit over 19 on March 10, gapped up the next day to 22 3/8 (point a), immediately dropped to 21 1/4 (point b) then climbed to a bit over 24 (point c).

If the story were weaker, the dip normally would have been greater and the bounce less. If my tracking diary shows that my gainers are dipping a small amount then bouncing a good percentage, I would be looking to buy at point b if the first low can be clearly identified. My exit point would be at the first sign of weakness, as usual.

In my

March 6 column, I discussed how to play overnight dumpers for the gap. Overnight gainers are played in much the same way, only the criteria change. As with dumper gap plays, I almost always wait until the last five minutes of the market to buy. This ensures the momentum and direction is clear at the end of the day. There are five criteria for playing a gainer for the gap at the end of the day:

  • All heavy buying comes in the last five minutes.
  • The stock ends up near the top of the pattern (near the high of the day).
  • Gainers are currently gapping up (only your tracking diary knows this).
  • General market conditions are positive.
  • The strength of the news causes the momentum.

As with dumper gap plays, I always sell at or before the opening bell the next day.

You will note that the two patterns above for Software Spectrum and American Software appear to be classic overnight gainer gap plays. American Software gapped up more than three points, yet we did not play any overnighters on March 10 because the majority of the stocks failed to meet one criteria -- all heavy buying in the last five minutes.

Almost all the gainers I was watching showed too much selling and I decided to stay out. The following Monday, March 13, showed that I was right. Of the previous day's gainers, 99% actually gapped

down

a great deal.

Remember, I play the percentages. I only play stocks when I am able to clearly identify how they will react

a good percentage of the time

. I do this by playing only a few patterns that repeat themselves over and over again once they meet certain criteria.

Next week I will tell you how I play one of the most misunderstood concepts in daytrading -- news plays -- and how to interpret the news. Does anyone know how to put together a 1965 21-inch,

Zenith

TV?

Ken Wolff is founder and chief executive officer of Paradise, Calif.-based

MTrader.com, an interactive educational daytrading and swingtrading Web site that teaches traders how to create their own disciplined, high percentage trading programs. While Wolff cannot provide investment advice or recommendations here, he invites your feedback at

ken@mtrader.com.