Chrysler (DCX) New Momentum High and Impulse Buy example

Mar 26, 2007: 1:24 AM CST

I wanted to point to a recent, clear example of the “Impulse Buy” trade I’ve been referencing. The chart ends March 23:

A few highlights:

  • Note the consolidation (base) preceding the move
  • The new momentum high drives price sharply up as news broke (Chrysler may be a take-over candidate)
  • New traders entered after the news broke and probably sold as price (naturally) pulled back
  • The “Impulse Buy” pattern places your entry when price retraces back to the 20 period moving average
  • A “Rinse” (perversion) trade occurred and likely took out stops of those who placed them too close to the average
  • Price quickly rocketed upwards in the intended direction for those who “held on” through the rinse
  • Target #1 is the most recent swing high ($74) which was achieved (a great place to sell half the position)
  • Price is now overextended to the upside, making new upside potential very limited

While this particular technical pattern was caused by news and rumor (private equity or an unknown company may be buying portions of Chrysler), the pattern played out as perfectly as an Impulse Buy pattern could unfold (with the exception of the “Rinse” into the area of tight stop-loss placement).

A few lessons:

  • Establish positions AFTER the retracement following a key breakout and new momentum high (new price highs are likely to follow)
  • Give the position a bit of leeway to avoid rinses and washes beneath your entry
  • News events often serve as the impetus for the Impulse Buy pattern, but cannot be predicted in advance
2 Comments

2 Responses to “Chrysler (DCX) New Momentum High and Impulse Buy example”

  1. Jordan Says:

    Hi Corey,
    Trying to comment here to see if it works…How much of leeway do you usually give to avoid rinse and wash situation, but yet ensure that the stop is not too big to stomach?

  2. Corey Says:

    Hey Jordan.
    In the past, I placed stops “Just beyond the point where your idea would be proven wrong” ie. just below a trendline or moving average (if you buy based on price touching a rising moving average, if it falls below, you’re idea was wrong, right? Not always). However, I got stopped out more times than I was happy with and got very frustrated (even developed terms for it: “perversion trade” or “perversion stop”) and decided I had to lower my stop.

    When swing trading, I force myself to allow at least one dollar of ‘stoppage’ but this is really dependent upon the stock (higher volatile stocks must have larger stops). Using Average True Range is a good way to do so, as well. I once used 25c or 50c on a swing trade, knowing I had a great entry, but that strategy rarely worked as it does in the ‘textbooks’. It feels so good to have a tight stop, but that isn’t a good long-term profit strategy. Remember, trading success often comes down to who can take on the most “heat”.

    I personally think using 1 ATR or even 1.5 x ATR is a good stop for swing trades with potential profit targets of $3 to $5 dollars. When scalping, this is not possible, of course.

    In this case had I traded it (I did not see it until this weekend and the opportunity is missed), I probably would have placed my stop below the rising 50 period MA and entered when price first touched the rising 20 period MA. I would have expected a quick result, but that rarely happens, and would have been forced to endure a nasty rinse (just below the twenty, that is). Emotion (fear) would have probably told me to sell there (just before the big move). Let me preface: Placing a stop below the 50 MA is proper, but I would have probably placed it just below $66 (entry around $67.50 – big red bar before the rinse) and been rinsed (almost to the penny of where I likely would have placed my stop). I like to think I would have bought back when price crossed back above the rising 20.

    Stop placement is personal, and depends on your risk tolerance. Remember, if you just absolutely must place stops too close (my natural preference), write a command rule in your plan that says “if price rises above my buy point after I am stopped out, then I must buy back the stock”. This will help prevent missing out, or passing on the trade set-up altogether (which is what could happen after too many “rinse and wash” experiences).