Gaming HFTs Part III: Preying For Morning Profits

Gaming HFTs is a series of articles. Earlier posts can be found at Part I & Part II.

In this thunder and tumbleweeds market environment that I more thoroughly explained in my last article (Gaming HFTs Part II: Thunder & Tumbleweeds) , the momentum and liquidity can surge like a tsunami and dry up like the salt flats in a matter of minutes. Eat what you kill is the underlying theme in the trading game. As a profit hunter, one must go where the ‘action’ is and make sure the target has enough meat on the bones when you get there. This article will focus on how to find suitable trading candidates in the morning.

Playing the right stock is half the battle every morning. The key is to have a handful of candidates on the screen to stalk so that when one trigger fails, you have ample supply of alternate prey. The caveat here, however, is more than likely the momentum will move simultaneously so decisions have to be made quickly on the fly to drop and pursue another target or stick it out with the current hunt.

There are two types of prey. The first is your ‘core’ basket of stocks that you traditionally trade which should be aligned to the SPY or S&P 500 futures and you are familiar with, which I call stalking prey. Stalking prey tend to move in lockstep with the futures and SPY etf, but also can fall into those moody periods of fuzziness where set-ups which used to work a week ago get faded or fizzled, but will work again the next week. This can be anywhere from 5 to 20 stocks. These don’t get written off, just put on the back burner until momentum returns, stock like: EBAY, SBUX, HAL, ESRX, GMCR, CAT, CMI, BIDU, SNDK, CRUS, WDC. You should be very familiar with these stocks as they are regular ‘go-to’ bread and butter candidates.

Secondly, is the ‘fresh meat’, stocks that are gapping up or down based on news/rumors outside of the ordinary (futures based). You may or may not be familiar with them, but they are attracting the volume and momentum due to the exceptional nature of their gaps. These candidates pop up every day on most broker/charting platforms under the ‘Biggest Point Gainers/Losers’ scans. Finviz.com has a very nice market heat map, which shows bubbles of the big gappers and dumpers after 9am. This is always a go to spot for me. I don’t go by percentages but more so by point value. Either way, these stocks that may trade normally on any given day are injected with steroids that hulk them up for monstrous movement, due to the distruptive nature of their gaps. We call them gappers and dumpers. The gapper/dumpers get the morning spotlight, which in turn attracts the predators allowing them to (temporarily) inherit the most trade-able momentum and liquidity from the opening bell.

The DNA sequence of all gappers and dumpers are composed of three reactions off the market open with four possible outcomes: Trend, pullback, trend continuation or reversal, pullback, trend. The third reaction can be confirmed when it fills the opening gap level of the first reaction and continues beyond it or reverses there.

To put it more simply, conventional wisdom tends to assume stocks only move up or down at any given point in time, a coin flip that can only come up either heads or tails. This may be true from an outsiders view but that is comparing apples to oranges. Up or down is a component of a larger behavioral pattern. A better illustration of this with the coin flip example means most gapper/dumpers will either form the…

Heads – Tails – Heads outcome
Heads – Tails – Tails outcome
Tails – Heads – Tails outcome
Tails – Head – Head outcome

The initial reaction usually occurs in the first 5-10 minutes, the second reaction in the next 5-10 minutes, and third reaction in next 5-10 minutes…and I stress the word usually.

Remember, we are dealing with the essence of the markets, which is fear and greed on steroids captured in a live wire. Only the nimblest of experienced traders should attempt the first reaction. The second and third reactions are for the opportunistic profit hunters. The twist is that the secondary reaction can be identical to the third reaction. I know this may sound cryptic, but gauge that first 30 minutes every morning on those gapper/dumpers and you will notice the same pattern. If your trading methodology or system can capture these dynamics, then you got the right system.

The largest abundance of gappers and dumpers manifest during the quarterly earnings season. When the bell-weathers make the list, they pull the lower tier sympathy stocks in the same direction providing more opportunities. In fact, I like to take the secondary laggards when the leaders are gapping since there is a distinct lead indicator to follow.

The good news is fourth quarter earnings kick off heavy starting the 3rd week of October and lasts a good six weeks. Save the ammo as the fun will kick off shortly. I’ll get into the actual stalking and carving out the prey in upcoming articles.