A trader's first job is to limit risk. When a trader is able to effectively control losses in the event of an incorrect trade, the profits will often take care of themselves. One effective way to manage risk is to focus on trading opportunities where a stock is just emerging from a narrow range rather than trying to catch a stock after a wide-range bar. By sticking to stocks with as narrow a range as possible, a trader can employ a tighter stop loss, therefore reducing the risk as a multiple of the possible reward. While keeping your risk tight may expose you to more whipsaws, by waiting patiently for these narrow range setups to develop and then pouncing as the range is cleared, a trader can keep his or her win rate at acceptable levels. This concept has become even more relevant recently as stocks become extended from their prior bases. Traders should focus on stocks that remain healthy, but are not overextended. (For related reading, see Range Bar Charts: A Different View Of The Markets.)
Radware Ltd. (Nasdaq:RDWR) is a pretty good example of a stock that is still in a clear, healthy uptrend, but is not too extended. RDWR has been trading in a tight range since its powerful breakout in September. What began as a pullback has gradually transitioned into a tight consolidation. Eventually, RDWR will begin to emerge from this narrow range and provide a decent trading opportunity with a clearly defined risk level.
Arbor Realty Trust (NYSE:ABR) is another stock that is presenting a narrow range within a healthy base. ABR had a strong run in June and July before experiencing some volatility later in the summer. It has gradually settled down and is trading in a tight range as it holds above its 50-day moving average. A move above the $5.60 level could present traders with a good trading opportunity that would allow good risk management with a stop below the tight range. (For more, see The Anatomy Of Trading Breakouts.)
Baidu (Nasdaq:BIDU) is a perfect example of a really strong stock whose sharp ascent could present real problems for traders. Rather than attempting to latch on to this trend after a strong day, traders could wait for a narrow range setup that would allow them to drastically reduce the risk they are exposed to. BIDU may be setting up for this opportunity as it trades in a tight range after breaking above the $105 level. Traders should monitor BIDU to see if it can continue to validate this level as support by consolidating in its tight range. However, once BIDU begins to emerge from this range, traders may have a possible entry with a well-defined risk level.
Amerco (Nasdaq:UHAL) is an example of a stock that recently emerged from a narrow range setup. UHAL had a strong run in the middle of the year before settling into a consolidation between the $75 and $85 level that persisted for several months. It recently surged past this level on a high volume gap, which may not have presented many traders with a good entry. However, UHAL is pulling back to test this area as support, and could present traders with a second opportunity if it can form a few consolidation bars near this area and then resume the move higher.
The key for traders is to focus on limiting risk instead of setting your sights on the possible rewards. Attempting to enter a stock that is already extended from its base subjects a trader to the pain of a typical pullback within a stock's average trading range. A trader can greatly improve performance by focusing on improving entries at levels that limit risk. The four stocks above are close to presenting such opportunities, thanks to the formation of a tight range within an uptrend. (For related reading, see Consolidation Trading: Trade The Calm, Profit From The Storm.)
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At the time of writing, Joey Fundora did not own shares in any of the companies mentioned in this article.