Many traders concentrate on what a stock does after it opens and completely ignore one of the most important periods of the day, the premarket action. Checking the preopen is like sneaking a peek at a boxer you have never seen warming up before a fight. You may not be able to tell exactly what he is going to do when he comes out of the corner for round one, but you can certainly size him up and get a pretty good idea of how he fights, and his energy level and quickness.
Watching stocks is no different. You can see the pressures acting on stocks even before they open. About an hour before the open, I put a group of stocks on my screen that I expect to be active for the day. One method I use to find these stocks is to scan for premarket gaps (an open higher/lower than the previous day's close). Most of the online execution services have a scanning function, like the one below, incorporated into their software that allows you to easily identify these stocks.
Net Chg. %
41 5/8 S
Once I put the stocks that are gapping up on my screen, I watch the
volume of premarket trading, which shows me the amount of interest traders have in a particular stock. A single trade of 30,000 shares tells me much less than 30 trades of 1000 shares each. I tend to ignore big block trades unless I am attempting to determine institutional interest in the stock.
I also pay particular attention to the amount of upward or downward
momentum just before the opening bell. This is the most important period of the premarket action, since it tells me what the stock will do right out of the gate. This, in combination with the overall interest (volume) helps me determine how much carry-through a stock's momentum will have. If I see signs of selling just before the bell on a stock that is gapping up in premarket trading, it tells me to watch out for traders taking profits early on and I start looking to short at the first high.
Next thing I look at is the overall market to determine the macro momentum. If the
Nasdaq Composite Index
is strong and the majority of the leaders are gapping up, then I would expect these stocks to have sustained momentum at the open and play them accordingly.
On July 13, I was watching
because it was showing a premarket gap and considerable volume. The Nasdaq as a whole was looking pretty strong, and, in fact, had gapped up. The momentum looked strong premarket but the news driving the stock up was old and this was the second day it had gapped up, raising another warning flag for weakened momentum.
Its upward momentum was caused by a number of reasons but mainly because on July 10,
reiterated its strong buy rating on the company. Although the premarket momentum was strong, the news driving the stock up was old, so I chose to
short at the high instead of buying at the open because I felt the momentum would be short-lived.
As you can see from the chart above, BroadVision closed at 39 3/4 on July 12 and opened at 41 7/8, gapping up 2 1/8.
The chart above shows what happened to BroadVision on July 13. It took off from the open and hit its peak at 09:54 EDT at 43 15/16 where it put in a very clear top. At the same time as this top, a number of other stocks were pausing and showing a momentum shift downward. As the momentum shifted, I put in my short order and rode the stock down to 42 3/8 at 10:08 where the momentum paused and reversed again for a 1 9/16 profit.
The chart above shows an even closer look at the first top at 9:54 and the first bottom at 10:08. After covering my short and exiting the trade at 10:08 at 42 3/8, I decided to go long. After all, if I believed that the momentum had shifted enough to cover my short, then it must be good enough to go long. I entered the trade at 42 3/8 where the stock climbed 1/4 point, wavered and started to drop.
At the same time, a number of other stocks paused and faltered, including my indicator stock,
(the stock I expect to front-run the market). Seeing the momentum shift again, I exited the trade at 42 1/4, for a loss of 1/8.
This is where the hindsight monster will jump out and get you every time. If you look at the chart, you will see that shortly after my exit it climbed up to 43 1/2 and I could have made another 1 1/8 points. I normally do not enter a trade that falters like this until it drops at least another half to three-quarters of a point. I do this because the area where it falters creates a certain amount of resistance and when it does eventually bounce and I want to ensure it has plenty of bounce (upside) in it up to that resistance level in case the momentum can't make it through it.
I chose to not enter the trade again because it did not drop, but only faltered. Not always, but a good percentage of the time, stocks that falter like this only climb a small amount then drop again just as quickly. This time I was wrong, but over time, keeping to the half to three-quarters rule increases my winning percentages and keeps me out of the low-percentage trades. Opportunity loss is a lot less costly than chasing a dropping or sideways moving stock.
Don't let hindsight ruin a disciplined trading program, no matter what you think you shoulda or coulda done, regardless of what hindsight shows you.
The momentum I have been waiting for has returned to the market in the past few days and I intend to fully exploit every ounce of it in the coming week.
Ken Wolff is founder and chief executive of Paradise, Calif.-based MTrader.com, a daytrading and swingtrading Web site. This column provides general information about momentum trading. TheStreet.com has no affiliation with MTrader.com, and no endorsement of MTrader.com or momentum trading is intended. While Wolff cannot provide investment advice or recommendations here, he invites your feedback at