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Day Trading Techniques: the Slingshot

Day Trading Techniques: the Slingshot
March 06
18:36 2012

Day traders and short-term traders are constantly seeking techniques that exploit certain predictable patterns in equity price movements. One such technique is the slingshot, which is a subset of the broad momentum trading strategy.

The slingshot exploits a breakout that temporarily reverses before continuing. Though not every breakout will reverse direction, in many cases some traders buy as soon as the stock breaks out of its established price channel. The majority of the market, however, waits for a confirmation of the trend, and the breakout loses momentum. The traders who initially bought in exit their positions, at which point a larger number of buyers takes advantage of the better price and the stock continues more strongly in the trend direction. It is this sequence of events that drives the temporary reversal.

The proper setup and execution for a slingshot is as follows:

  • On Day 1, the stock achieves a new 60-day high.
  • On Day 2, the stock trades below the Day 1 low (not the closing price).
  • On Day 2 or 3, execute the slingshot (take a long position) if and only if the stock trades above the Day 1 high.

The slingshot can also be used with a downward breakout, merely by reversing the criteria and taking a short rather than a long position:

  • On Day 1, the stock achieves a new 60-day low.
  • On Day 2, the stock trades above the Day 1 high (not the closing price).
  • On Day 2 or 3, execute the slingshot (take a short position) if and only if the stock trades below the Day 1 low.

In neither case should you pursue the slingshot if the pattern takes more than three days to develop.

In uncertain markets, when you are bullish on a particular stock but prefer to minimize your exposure, you may choose to employ a modified version of the slingshot that combines the long position with options. Like its generic sibling, this modified slingshot seeks to capture a profit of about one Average True Range (ATR)—the average price range of a stock in a day’s trading within a given timeframe. (A stock will generally have a different ATR over six months than over three years, so the specified timeframe does matter.)

This hedged slingshot is constructed with the same long stock position (100 shares) plus the simultaneous purchase of two out-of-the-money calls for the next month. The long stock position is closed as soon as it captures one ATR, in effect paying for the cost of the calls. If you remain bullish on the stock, you can hold the options until you have achieved your desired profit. Otherwise, you can construct a bull call spread by shorting two calls for the same expiration month at a slightly higher strike.

Naturally, you should only use the hedged slingshot if you are comfortable with advanced option strategies and fully understand the construction and management of spreads.

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For either variety of slingshot, use limit orders to automatically exit the position once the stock price has achieved a one-ATR movement. Bear in mind that day trading and short-term trading require discipline to be successful. Don’t let greed tempt you into remaining in a position too long, or you may find yourself losing all of your gains and more.

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