General stock market indexes showed a lot of improvement this week. But some of the better looking swing trading setups didn't fare nearly as well. Li Auto stock is just one more example of why taking profits quickly remains our strategy in this stock market environment.
Swing Trading Example: Li Auto Stock
Li Auto sticks out among stocks because of how strong it acted while the stock market continued to hit new lows. The May lows below 20 in Li Auto stock (1), coincided with stock market lows. But then the Chinese electric-vehicle maker took a different road.
When the stock market had its follow-through day, Li Auto stock quickly moved above its 50-day moving average line (2) and then its 200-day moving average line (3). Then, as the stock market indexes undercut their May lows in June, Li Auto stock kept going higher. By the time it peaked on June 24 (4), it more than doubled in price with volume swelling on the move. The relative strength line soared to new highs.
With such heady gains, a pause is not only expected but welcomed. Breaks along the way give a stock a chance to recharge and give investors another shot at initiating or adding to positions.
Ideally, the pause after a stock's big move will be orderly and find levels of support. Li Auto stock delivered on that account.
Pullbacks Create Opportunities
It initially found support at its 10-day line (5). A couple weeks later, after crossing above 40, the stock pulled back again. This time, the rising 21-day line acted as a support level (6).
Usually, we aren't inclined to start positions with just a pullback to the 10-day line. In this case, the pullback to the 21-day line was basically to the same price level, just above 36, but the multiple tests and longer-term moving average line instilled more confidence.
Most importantly for the setup was that Li Auto stock refused to give back much ground after its strong gains. In fact, it started to look like a rare and powerful pattern: the high, tight flag. We used the 21-day line support as a buy signal and added Li Auto stock to SwingTrader that day.
Exit Strategy Just As Important As Entry Strategy
As always, we had an exit strategy in place along with our entry. For Li Auto stock, the low of our entry day coincided roughly with the 21-day line and seemed to be a good area for a stop loss. A close below that level would be a clear signal that the support level failed. But at just under 5%, the risk percentage was higher than our comfort zone.
Instead of skipping the trade, we adjusted our position size lower. A smaller position size can offer the same amount of portfolio protection while giving a more volatile stock the room it might need. It helps to avoid getting shaken out with a stock's normal activity.
While there were plenty of positives for Li Auto stock, we are still sticking to taking profits quickly when we can. Since Li Auto moves more, we took our first third profit when we had a 5% gain (7). That action saved the trade.
The following day, Li Auto stock pulled back to our entry (8). Once we have a 5% gain, we don't want to let a stock go negative.
At first the day looked like it closed well and was just another example of support at the 21-day line. But things got worse from there.
After Friday's action, the high, tight flag seems to have lost the tight part of the description. By taking the first profit quickly and exiting before it got worse, we left the trade with a small gain instead of a big loss.
More details on past trades are accessible to subscribers and trialists to SwingTrader. Free trials are available. Follow Nielsen on Twitter at @IBD_JNielsen.
