Our second profit target is created in the exact same way. We would take our range, which is 86 cents, and add it to target #1, which is $45.44. It’s a little bit easier for me to take the target #1, of $45.44, and just add the 86 cents to it, to get target #2, which is $46.30.
To calculate our third profit target, all we have to do is add 86 cents to profit target #2, and we come up with profit target #3. In this particular example, we count the Inside Day as Day 1. We count the very next day as Day 2, and the day after that as Day 3, and Day 4 is the day after that.
In this particular instance, we would have entered this position precisely at $44.58, when the stock began to trade one penny above the prior day’s high, of our Inside Day. Our first target was hit on the very next day, as $45.44. Generally, conservative traders will get out at that point, take a profit, and move on to the next position. If you’re a slightly more aggressive player, you might want to take half of your position at Target 1, and move your stop loss up to break even at your entry point, at $44.58.
That way, at least you have a profit on half of your shares. On the remaining shares, you would have a breakeven point of $44.58. If, in fact, the stock continued to trade higher and hit Target 2, as it did in this example, you would then sell out another 50% of your shares, at $46.30.
In this particular case, if we had 1000 shares entered at $44.58, we would immediately sell half of those shares, or 500 shares, at $45.44, and move our stop loss up to $44.58, our entry price, on the remaining shares. As our stock continued to trade, and hit Target 2, we would sell out 250 of the remaining 500 shares – another 50% of our remaining position – at $46.30, leaving us with 250 shares.
This particular example did not hit our Target 3 of $47.16. As we get into the days, we have one day, two days, three days, four days. We have a fourth-day rule, which states that you are either to exit the position at the close of the third day, or the open of the fourth day, whichever fits your comfort and trading style the best. This trade is really meant to work very quickly.
In other words, after the fourth day, if you’re not hitting your profit targets… That could happen. The particular type of strategy that we’re using generally will have an explosive move like this one. Sometimes, it’ll just kind of hang around down here, and it won’t make any progress at all. If that’s the case, on the fourth day, whether or not we hit our profit targets or not, you will want to exit this trade. If it’s not working out after the fourth day, you want to exit it. This trade is meant to work very quickly, and if it doesn’t, that means there is something wrong. You really want to get out of the position.
Aggressive traders may – if after the fourth day, none of the profit targets are hit, you may want to exit the majority of your position, but keep a little bit, just in case the move starts a little bit late. The one thing I should mention right away is, once you do enter the position, you want to set a stop loss limit at the opposite end of your Inside Day.
In other words, let’s say you set up an entry at the $44.58, to go long on the position. You had an entry of $43.73 cents, in order to go short on the position. Once one side of your entry is filled, if your $44.58 long position is entered and filled, then you want to change the short order entry to a stop limit. That will be your stop loss limit right here, at $43.70, as you begin this trade.
Once you see the position actually starting to hit your profit targets, you might want to raise this stop limit now, up to 50%, or this 25% top line, or maybe even your breakeven point. In other words, once your position hits your profit target #1, you may want to just lift this stop loss up, along with the price trend, and follow along with it. If you hit your profit target, and you don’t exit 100% of your position, you want to make sure that you raise your stop loss along with your profit targets. If there is a quick reversal, you’ll be able to get out, and still maintain your profitability in the position.
Let’s talk about trade management for a second. The benefit of the trade setup really is that it’s mechanical. You have precise entry points for your long position. You have precise entry points for your short position. You really don’t have a lot of choices in the trade, when it comes to entering the position. You’re going slightly above the high of this inside bar, and slightly below the low of the inside bar.
In some cases, as I mentioned, aggressive traders can take positions. Let’s zoom in here. Within these 25% channel lines, aggressive players may want to enter a little bit early, in anticipation of a breakout to one direction or another. That’s for aggressive traders only. In most cases, you’re probably better off waiting for your entry price, which is one cent higher than the high, and one cent lower than the low of our Inside Day.
In some circumstances, there’s actually a fakeout. In other words, it breaks out of the high of the Inside Day, but immediately reverses and goes lower. I’ll show you an example of that very soon. If that should happen, there’s actually an opportunity to reverse your position. Even though you’ve gotten stopped out, and the position continues to go lower, you may have an opportunity to stop and reverse your position, and go short, once it hits the lower end of your entry and your short entry position.
That’s really a rule for aggressive traders. I’ll show you an example of that. It’s really quite interesting. The reason why that actually works out well is, if the fakeout comes to the up-side, all of a sudden, the bar reverses, and the day reverses, and goes much lower, to the down-side. There’s a piling-on effect. People know that if it broke through, they were buying the stock in anticipation of a break-out.
All of a sudden, the bears came in, and started selling like crazy. There’s a piling-on effect, of people who had purchased the stock here, now have to sell the position. They’re selling it at a much lower price, continuing to fuel the selling pressure on the stock, driving the stock even lower.
Here’s an example, in Chesapeake Energy, of exactly what a fakeout looks like. You have an inside bar, which is a relatively narrow inside bar, at least 50% or less of the bar that precedes it. This particular Inside Day, if you were to trade this, you would have entered a short position of $49.02.