By Larry Benedict, editor, Trading With Larry Benedict
New traders waste a lot of time.
They have no respect for risk. And they fill their charts with lines and indicators that create all sorts of noise.
They chase hot stocks and jump from one trading strategy to another.
The end result isn’t pretty.
I know because over my 40 years of trading, I’ve made every rookie mistake you can think of.
Early on, I blew up my own account more times than I care to recall.
But I never gave up on my goal of becoming a successful trader.
And once I discovered the power of having a disciplined approach, I went on to deliver 20 years in a row of profitable trading during my hedge fund days.
Discipline comes down to a couple of important things.
One is respecting risk…
But another aspect of discipline is how you select trades.
Think of it as your “trading edge.”
Successful traders are obsessive about developing their edge. They stick to a formula that works… instead of jumping from one strategy to another.
So today, let me pull back the curtain on how to fine-tune your edge…
Developing Your Edge
Most experienced traders fall under one of two categories when it comes to developing their edge: trend-following or mean-reversion.
Trend following is exactly what it sounds like. Traders attempt to spot a price trend and get in as soon as possible.
Think of it like a surfer catching a wave.
Trend followers try to catch the wave as it starts emerging and ride that wave for as long as possible.
On the other side, mean-reversion looks for a price trend that has gone too far in one direction and is ready to reverse course.
A mean-reversion trader wants to profit as the wave starts to crest and roll over.
A sudden change in direction is the profit opportunity.
Most of my trades fall under the mean-reversion category. Knowing when a trend is about to reverse course is a trading edge that has served me well.
That’s because I can leverage big gains in a short time from a change in price direction… up or down.
In fact, I recently used my edge to bag a 66% gain in just four days on a pullback in one of the hottest stocks around…
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Playing NVDA’s Extended Trend
Every bull market has its superstar stock. And this one is no different.
At one point, Nvidia (NVDA) was up 174% year-to-date. That made it the most valuable company in the world.
But around the same time, I knew the stock price had risen too far, too fast, and was reaching an extremely overbought condition.
Check out the year-to-date chart below of NVDA:
The Relative Strength Index (RSI) at the bottom is useful for spotting overbought and oversold conditions.
Typically, overbought occurs when the RSI jumps above the 70 level. NVDA went above that level back in late May.
But mean-reversion isn’t just about tracking the RSI. You can see it stayed above 70 into late June.
So we also need to analyze price action for signs of weakness as well.
In my options trading advisory The Opportunistic Trader, I added put options on NVDA on June 20. Put options gain in value if the underlying stock price declines.
And look at what happened to the stock price on June 20 in the chart below:
After surging to a new high, the stock made a sharp reversal (the black arrow). That’s a major sign of exhaustion in the price trend.
Along with the overbought RSI, this told me the stock was finally ready to pull back.
So I recommended put options that day on NVDA.
And four days later, we finished selling our position for a gain of 66%.
By developing your trading edge over time, the goal is to identify more and more of these setups. That lets you bring in consistent gains no matter what the overall market is doing.
Regards,
Larry Benedict
Editor, Trading With Larry Benedict