Whenever I post an educational trade review on this blog, the technical trade setup is usually of the breakout or pullback variety.
Today, I’m excited to walk you through a different kind of trade that was recently bought and sold with a 15% price gain over just a 3-day holding period.
Trading The “IPO Momo” Setup On A Pullback
Because recent IPOs trade with a limited price history, it is frequently challenging to apply standard technical analysis techniques to determine ideal, low-risk buy entries.
However, even though recent IPOs lack extensive price data, the same technical analysis strategies I use daily for finding high-momentum breakout and pullback setups works great for recent IPOs.
The main difference is that this type of momentum (momo) stock trade is viewed with a much shorter time horizon of days, rather than weeks or months, because of the more limited price history.
In the first chart below, I have highlighted the initial pullback in Arista Networks (NYSE:ANET) that caught my attention late last month:
With the “IPO Momo” trade setup, I look for a substantial move higher in a recent IPO, followed by a lighter volume 50% to 61.8% Fibonacci retracement (pullback to support).
Upon spotting such price action, the stock enters my internal watchlist as a potential short-term momentum trade, BUT I also wait for a bullish reversal candle (or opening gap higher) to form.
Waiting for the formation of a reversal candlestick on the daily chart, then planning a buy entry above the high of that candlestick, is a great way to lower your risk because it helps to confirm that the pullback off the highs is likely finished.
The next chart of ANET shows how the pullback led to my buy entry setup a few days later:
As annotated on the chart above, the bullish reversal candlestick that formed on June 25 was followed by two consecutive inside days.
This pattern provided me with a low-risk buy setup in ANET if it rallied above the downtrend line of the pullback.
As such, I officially added ANET to the stock watchlist section of my nightly stock pick newsletter on the evening of June 29, and provided subscribers with my exact buy trigger, stop, and target prices for this IPO Momo trade setup.
When A Rally Is Too Strong
The following day (June 30), ANET triggered my buy entry by gapping open above the downtrend line and prior day’s high.
Although ANET closed weak on the day of entry, the stock rocketed 21.8% higher the following day.
Initially, I was quite pleased by such an explosive move just one day after entering the stock.
However, upon further analysis, I felt the July 1 rally could actually be a sign of near-term exhaustion (due to the monstrous move in terms of price and volume).
If it was indeed an exhaustion move, I did not want to stick around in ANET because it would likely just chop around in the days and weeks that followed.
As such, I raised my stop price to protect the quick and easy gain of the prior day:
As highlighted on the chart above, ANET hit my tightened stop the following day, enabling me to lock in a quick 15% gain with a 3-day holding period.
Why Trail A Stop Instead Of Simply Selling?
If i was concerned that ANET was facing price exhaustion, you may be wondering why I chose to raise my stop, rather than just selling to lock in the easy profit on the following day’s open.
The tightened stop (rather than immediate exit) would still allow subscribers to participate in further upside potential, just in case $ANET had a bit more bullish momentum remaining.
More specifically, I was willing to risk giving back 5% or so in profits to potentially catch another 10-20% run.
Obviously, I indeed gave back about 5% of the gain by trailing a stop, but I still made the correct decision and faced no regret (one of the 4 most dangerous emotions for traders).
Luck…Or Not?
The explosive rally of July 1 was admittedly triggered by news of a brokerage upgrade that morning.
Therefore, one might reasonably argue that this winning stock trade was merely the result of luck.
However, I have learned over the years that good things happen when you buy the right stocks at the right time, especially in a strong market.