In this article, you will learn how to find stocks that are ready for an explosive move and how to trade these stocks for a profit.
There are 2 fundamental steps to trading success:
1. Find the best stocks with the highest profit potential
2. Know when to exit (aka “The Perfect Exit”)
3. Know when to exit the trade with a loss
Let’s start with …
Step 1: Select the Best Stock.
So, what kind of stock are we looking for?
We need a stock that’s ready to move! We want to catch a stock early in an up-move.
Well, I think Newton said it best: “An object that is in motion stays in motion.”
You want to buy a stock that has made a bottom, and is now on its way up again. Or you can buy a stock that has been moving sideways and is now moving up again (see picture 1).
Always keep in mind: The trend is your friend
There are easy ways to find these kind of stocks – stocks that are starting to move up and have a high likelihood of continuing to move up.
I personally use 3 indicators to identify these stocks. For me, indicators are the best way to find stocks with high profit potentials.
Why? Because they are easy to use.
For me, they are way easier than all these chart formations like cups, and head and shoulders, and triangles, and all this stuff.
And they are even easier than Candlesticks – at least for me.
So here are the 3 indicators I like to use:
1. The Slow Stochastics (StochD_ with a setting of 14, 3 and 3
2. The Relative Strength Index (RSI) with a setting of 7 and
3. The MACD with the setting of 12, 26 and 9
Every charting software has these settings, and in a minute, you will see them in action.
So why do I use three indicators?
I use 3 indicators to increase the accuracy. If you use only one indicator, your will get false signals.
By combining 3 powerful indicators, each one confirms the others and you get much better signals.
Ok, let’s take a look at some examples.
So, here you see the Slow Stochastics Indicator (StochD) with a setting of 14,3 and 3.
And here’s how to use this indicator.
You want to pay close attention to the 50-level. The indicator oscillates between 0 and 100, so 50 is right in the middle.
Whenever the Stochastic is above 50, it’s indicating that the market is in an uptrend, as highlighted in the green box below:
And whenever this indicator is below 50, it’s indicating that the market is in a downtrend, as highlighted in the two red boxes:
Of course we don’t only rely on this one indicator. We are using three indicators to determine our entries, remember?
So let’s move on to the next indicator.
The next indicator is the Relative Strength Index (RSI), and we are using a setting of 7.
Here’s how to use this indicator:
Same as with the previous indicator, we want to mark the 50-level right in the middle.
Whenever the RSI is above 50, it’s indicating that the market is in an uptrend, like here:
Whenever this indicator is below 50, it’s indicating that the market is in a downtrend, like here:
Let’s do a quick recap: We talked about the first two indicators: Stochastics and RSI.
When these indicators are above 50, it’s indicating an uptrend.
And when they are below 50, it’s indicating a downtrend.
Easy enough, isn’t it?
Let’s take a look at the third indicator now: MACD (12, 26, 9).
Usually the MACD has 3 lines, but all we need is the MACD itself. And since I like to keep it simple, I use only the line that I need. I like my charts clean.
So here’s the third indicator: MACD.
Here’s how to use this indicator:
For this indicator, we want to mark the zero line.
Whenever the MACD is above 0, it’s indicating that the market is in an uptrend, like here:
And whenever the MACD is below 0, it’s indicating that the market is in a downtrend, like here:
Now we need to combine everything that we have learned thus far and we will get our entry signals.
Let’s take a look:
For an uptrend, we want
As long as ALL of these three conditions are true, we have an uptrend.
In the picture below I drew a blue line as soon as all of these conditions were met.
There’s also a red line that shows you when the MACD is no longer below 0.
This means now only two of the three conditions are true, so the uptrend is over – for now.
So here’s what I like to do in my charting software:
Whenever all of these 3 criteria are true, I color the bars GREEN to make it easy for me to see when a stock is going up.
Let’s take a look at the downtrend now:
For a downtrend, we want
As long as ALL of these three conditions are true, we have a downtrend.
In the picture below, I drew a blue line as soon as all of these conditions were met.
There’s also a red line that shows you when the RSI is no longer below 50.
And we see that the MACD is also above 0 at this point.
This means now only ONE of the three conditions are true, so the downtrend is over – for now.
And again, because I like it simple, here’s what I like to do in MY charting software:
Whenever all of these 3 criteria for a downtrend are true, I color the bars RED to make it easy for me to see when a stock is going down.
So let’s take a look at a chart now without all these additional lines that I have drawn.
Whenever all three conditions for an uptrend are true, the bars are GREEN.
And when all three conditions for a downtrend are true, the bars are RED.
This makes it very easy for me to see when a stock is going up and when it is going down.
Easy enough, isn’t it?
THIS is probably the most important step, and now you have a solid foundation:
You know EXACTLY when a stock is going up and when it is going down.
So let’s move on to the next step.
Step 2: Know when to exit a trade (aka “The Perfect Exit”)
Ok, now that we know how to spot a trend and when exactly to enter, let’s talk about “The Perfect Exit”.
After all, money is made and lost when we EXIT the market. That’s why exits are so important.
The entry is putting the odds in our favor. And once we are in a trade, we need to focus on exits.
Most traders get this wrong: They are focused on the entries only, and once they are in the markets, they don’t know when to exit. Don’t make this mistake!
So here are two key concepts when it comes to exits:
So let’s talk about the first concept: Keep your losses smaller than your profits.
THIS is the secret that turned my trading around, and in a moment you will see why.
Key #1: Keep your losses smaller than your profits.
And here is why this is so important:
When you keep your losses smaller than your profits, you will still make money even if half of your trades are losing trades.
Let’s say your stop loss is $200. So, every time you have a losing trade, you lose $200.
And let’s say your profit target is $300. So, every time you have a winning trade, you make $300.
So now you have 10 trades and 5 of them are winning trades and 5 of them are losing trades. This means half of your trades are losing trades. So, let’s see what happens:
On your winning trades you make $1,500. You have 5 trades and make $300 on every winning trade. That’s $1,500.
On your losing trades you lose $1,000. You have 5 trades and lose $200 on every losing trade. That’s $1,000.
So how much do you have left after 10 trades?
After 10 trades you still have a profit of $500.
Half of your trades were losing trades and you STILL make money! This is the real power of this concept!
Let’s move on to the next concept:
Key #2: Always know when to exit!
Always know your risk and reward BEFORE you enter the trade.
Because it reduces stress!
Most traders get this wrong: They put all their attention on the entry, and once they are in a trade, they wonder: “Well, what now?”
You want to know when to exit BEFORE you enter the trade.
Because THIS is the ONLY way to apply proper position sizing! And proper position sizing and money management is the key to trading success. Without proper position sizing and money management you can still lose money EVEN THOUGH you have a profitable trading strategy!
And if you don’t know when you exit, you won’t be able to apply position sizing and money management.
Finally, knowing when to exit will allow you to put the trade on autopilot and therefore eliminate emotions. And emotions are the biggest problem for most traders.
THE SPECIAL OFFER
Click on the button below to sign up for a free training class on how to trade with this strategy.
All the best in your trading!
Author: Markus Heitkoetter, Founder
Company: Rockwell Trading
Services Offered: Trading Education, Software, Trade Alerts
Markets Covered: Stocks, Futures, Forex, Nadex
Markus' claim to fame is that he can teach anybody how to trade in 60 minutes or less. That's how simple yet powerful Markus' trading strategies are.