As most experienced traders say, "buying is easy, it's selling that's the hard part." The goal of every market participant is to buy an asset when the price is low and sell it right before the price crumbles. Trying to pick the top of any movement in the financial markets is not easy and luck often plays a bigger role than most traders would like to admit. Lucky trades can be part of trading, but traders shouldn't let good luck go to their heads - a strategy that wishes to stay profitable over the long run cannot depend on luck for its superior results.
This article is an example of how we got lucky by selling at the top. While this is a success story, we'll also emphasize why you should not rely on luck alone.
On March 16, 2006, ChartAdvisor.com identified a potential inverse head and shoulders pattern forming on the chart of Cosi Inc. (COSI). As you can see in Figure 1, traders will spend countless hours seeking out this chart pattern because a furious break higher usually occurs once the bulls are able to send the price of the asset above the resistance level known as a neckline.
The identified inverse head and shoulders, shown in Figure 2, was in the process of forming the right shoulder when we added the pattern to our watch list. The underlying thesis behind this trade was a bet on the bulls entering buy orders for COSI when the price was able to break above the neckline of $10.11, which would then result in a surge toward our target of $11.21. Notice how the pattern below is very similar to the theoretical diagram because this figure is a good example of the type of breakout that we were expecting to see when the price was able to surpass the neckline. (For more insight into how to spot this pattern, read Basics Of Technical Analysis and Price Patterns - Part 2.)
As you can see in Figure 3, this trade began to develop as we anticipated, with a break above the entry price on March 28, 2006. The large volume that accompanied the breakout was noted to confirm that the break above the entry was valid and that a further move higher was to be expected.
For our COSI trade, luck was on our side for the two days following the breakout because we saw the price of the shares reach our target - a price that also happened to correspond to the day's high. Every trader would like to close a long position at the day's high, but because nobody knows exactly what this price will be, it takes some luck in order for this to occur. (For more on this, check out Trading Failed Breaks and Support And Resistance Reversals.)
Luck continued to be on our side in this trade as the bulls were unable to maintain the upward momentum that was started with the break above the neckline. As you can see in Figure 5, the price of $11.21 turned out to be the highest price (to the penny) to which the bulls were able to send COSI before the bears took control and sent the stock lower by more than 50% over the following four months.
At ChartAdvisor the outcome of the COSI trade was extraordinary - we never expect to be able to pick the exact top before the market sends an asset lower. In this regard, we got lucky with COSI. Although this type of trade could fuel a trader's ego, it is important to avoid becoming overconfident as a result of of one exceptional trade. After all, it can be just as common to look back on a trade and see that it continued to move in the desired direction after it was closed out.
For example, as you can see from the chart of Delta Petroleum (DPTR), an earlier pick from ChartAdvisor, we recognized an inverse head and shoulders pattern and were closed out of the trade when our stop-loss order was triggered for a 5% gain. Notice how in Figure 6 the bulls continued to push DPTR higher after we had left our position.
From our COSI trade we realize that luck can play a great role in the outcome of a trader's most memorable transactions and that the key to being successful over the long run is to never rely on this luck. Basing a trading strategy on time-tested methods that have proven their worth over hundreds of years has lead us to accept the situations that are beyond our control, both good and bad, because over time, strategy is what is going to keep us in the trading game. Selling at the peak is the exception and not the norm. As a result, traders must be willing to stick to their trading strategies.
To read more of ChartAdvisor.com's lessons from trading, see Tales From The Trenches: Hindsight Is 20/20.