A breakdown of low-risk entries…some are actually a bit more risky than you think.

Discussed in this article: McDonalds Corp ( $MCD )

Lets look at McDonalds ( $MCD McDonald’s Corporation ) here. You’ll notice the date on Thursday the 18th. I want to look at this basically to talk about how to get a low risk entry; this is really not it.

Now, I like to talk about these long tails, when a stock is kind of pulling back and then at some point it trades down big intraday, you know, opens up near the top of the range, the ultimate range, trades down big intraday, and then comes back up and closes near the top of the day. I look at that as basically like a bear rush in the morning and then the bulls came and finished them off and now their going to take the stock higher. So you would look at this and say, “Well this is a good time to enter,” and then you keep your stop right about there.

Well, there are a couple of problems with that when you think about it. Now, it may ultimately work, it didn’t in this case which I’ll tell you about in a second, but it may ultimately work, but it’s not particularly low risk entry and here’s why.

Draw the resistance line, you can draw support along the 50-day moving average, you can draw it along the 20-day moving average, okay, that’s fine. But if you’re buying this stock right now, what’s your upside before you can anticipate this stock doing what it’s been doing here in the channel and that is coming up and then falling back down? It doesn’t have to move up very far, doesn’t have to move up very far before it rolls over, basically not giving you much reward, it doesn’t give you much reward for taking the risk.

On the other hand, what is your risk? Well, the stock could fall clear down to here, you’ve got your stop down here, you know, based on this tail here you’ve got your stop down here. Well that doesn’t work either because now you get stopped out, the stock ultimately comes down to test the 50-day moving average, as they tend to do, then it races off without you, and you’re saying, “Well, stops don’t work, or whatever, the markets rigged, or oh my gosh, I goofed up, I shouldn’t have bought McDonalds ( $MCD McDonald’s Corporation ),” and that’s not really the case. It’s just that the entry was not a low risk entry, so this is the kind of thing where, look if you’ve got a long-term time horizon then fine, this is a great time to buy McDonalds ( $MCD McDonald’s Corporation ) and I think that every long-term investment kind of starts with a long-term trade.

So what ultimately happened was, we got the intraday reversal, but it was too far up above support and too close to resistance to give you an ideal entry; so you say, “All right, as a trader I’m not going to take that entry, maybe the stock goes up without me, but it’s a bad entry.” I always talk about the two sides of risk; everybody seems to just think about risk in one dimension, “Oh, I don’t want to lose money.” But there’s the other side which is, if you don’t jump in a stock you risk missing out on the upside. That’s the risk that nobody thinks about, but it’s true, you’ve got to be thinking about that, so there’s two sides to risk.

Here the risk of missing out on a bunch of money was actually pretty low because you got your resistance right there, so there wasn’t a real risk of this stock getting away from you. On the other hand there was a greater risk of the stock pulling back and so the risk of losing money out weighed the risk of missing out making money so you don’t take the trade. Now comes yesterday, Monday, the stock comes down and tests the 50-day moving average. Now we draw a line along the 50-day moving average, well it’s bounced right off of support. Now we draw this line up here, this stock could go up if the uptrend continues, stock could go up, what, another five percent or so before hitting resistance; this is a good entry.

Now again, if we go to the weekly chart you’ll see, I think you just buy McDonalds ( $MCD McDonald’s Corporation ) and stay McDonalds ( $MCD McDonald’s Corporation ), you’ve got to go with Ronald McDonald, he’s going to make you money. The point is now, with the stock having bounced off of the 50-day moving average, now you can buy this stock, start a small position, put your stop right underneath that level and then as the stock works its way higher then maybe you buy a little bit more.

I know you’re averaging up, but that’s the whole point of trading and my view is, you find out where the bottom is, make sure that trade is paying you off and then start packing it on when the trade is telling you’re correct. When the stock is telling you that you’re correct that’s when you start increasing your risk, as opposed to when the stock is telling you you’re not correct and you’re sitting there buying it all the way down saying, “Well, sooner or later I’m going to be correct.” Well that didn’t work out too well for Apple ( $AAPL Apple Inc. ) did it?

So McDonalds ( $MCD McDonald’s Corporation ) I think this trade is going to work for you. This is a short-term trading technique that I’m talking about. You can apply it way beyond McDonalds ( $MCD McDonald’s Corporation ), McDonalds just happened to pop up on my screen. I liked the way this stock was looking for this lesson. But McDonalds ( $MCD McDonald’s Corporation ), it’s a Dow component, this is why you got to like McDonalds ( $MCD McDonald’s Corporation ), because it’s creating this rounding bottom, now it’s up at what could be a double top, you got to take that into account, but if the stock continues to move higher then what could have potentially been a double top was actually just one big year-long consolidation before McDonalds ( $MCD McDonald’s Corporation ) heads higher.

So anyway that’s a long-term outlook on a stock with a short-term trading tactic for those of you that get the itchy trigger fingers.

Free Chart

Leave a Comment