Although the March 16 follow-through day looks like a failure, it doesn't mean there weren't strong stocks out there. CAT stock rallied with the indexes in March and had a swing trading setup in April. But it didn't last. Here's why we made a quick exit.
Swing Trading Example: CAT Stock
Caterpillar isn't usually thought of as a high octane growth stock. But with the move in miners this year and setups in heavy construction stocks, CAT stock didn't seem like a crazy idea for a watchlist.
From its Feb. 24 low, CAT stock got back above both its 50- and 200-day lines (1) well before the S&P 500. And after rallying more than 25% off its bottom (2), it held the bulk of its gains and traded tightly right around its 5- and 10-day lines.
That tight action was the attraction for adding CAT stock on SwingTrader (3) as the S&P 500 pulled back to its 50-day moving average. Confirming the strength was above-average volume (4) to accompany the price action and a relative strength line stretching above recent highs (5). But all the positives in the world shouldn't deter you from having an exit strategy. We used the low of the entry day as it calculated out to a manageable risk of just 3.2%.
Taking Profits Into Strength
As good as the action looked on CAT stock, the overhang of the general market was worth paying attention to. With a 3% gain from our entry, we locked in our first third profit (6). Yes it means reduced participation if the stock works well, but it also makes it easier to exit a trade with a gain should it reverse.
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We slowly made progress and hit 5% profit in CAT stock on April 21, early in the trading session (7). We considered taking another round of profit at the open but we already had low exposure overall. Still, we often raise our stop to the entry price once we have a 5% gain to protect profits.
By the end of the day Caterpillar showed an outside day with a close near the lows.
Usually downside reversals like this lead to more weakness. In fact, a number of positions exited SwingTrader that day on that exact signal, halving our already diminished exposure.
Caterpillar at least had a narrower trading range between the high and low compared to its average activity. The unusually small trading range the prior day was also a factor in making the outside day a little easier to appear.
Escalator Up, Elevator Down
Still, we were on high alert. CAT stock gapped down at the open (8) and we removed the remaining position at 226.36 before it fell below our entry price. By the end of the day, Caterpillar not only went below our entry price but also below our original stop at the entry day's low.
Two weeks of gains got wiped out in just two days. Just another example of how stocks take an escalator up and an elevator down.
Our early profit taking plus our final exit above our entry kept the trade positive rather than letting the gains turn into losses. After such a sharp move down it's easy to hope for a comeback. Cats might have nine lives but that doesn't necessarily apply to stocks.
More details on past trades are accessible to subscribers and trialists to SwingTrader. Free trials are available. Follow Nielsen on Twitter at @IBD_JNielsen.
