New traders waste a lot of time.
They have little respect for risk.
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 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 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 a 20-year winning streak during my hedge fund days.
Discipline comes down to a couple of important things.
One is respecting risk, like I’ve shown previously.
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 for 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, earlier this year, I 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.
This summer, 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 it was reaching an extremely overbought condition.
Check out the chart below:
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 sold our position for a 66% gain.
By developing your trading edge over time, the goal is to identify more and more of these types of setups.
That lets you bring in consistent gains no matter what the overall market is doing.
Happy Trading,
Larry Benedict
Editor, Trading With Larry Benedict