Today is a special day, we are launching a new product called ‘Profit Behind The Blog’. This is the service where I show you exactly how a Hedge Fund Trader would trade a specific stock.
This service combines education with the potential to profit because I will highlight specific trading levels, entries, stops and targets.
This article is a continuation on ‘Has Disney Lost Its Magic? Hedge Fund Trading Lesson Featuring Brett Favre‘.
Step 1: I always try to get a feel of the long term history of the stock and compare it to the S&P 500.
We want to see the trend of the stock compared to the shape of the general market. We want to know if the stock is stronger or weaker than the market index.
We want to trade the stocks that are Stronger or Weaker than the market index.
Here’s the logic. My rule of thumb is to avoid excessive risk whenever possible.
Trading a single stock is riskier than trading a market index so we want to trade the market index when the market index and stock are moving in tandem with similar volatility patterns. We only want to trade the stock when it is much stronger or weaker than the market index.
Disney (NYSE:DIS) is much stronger than the S&P500. The S&P500 is only trading slightly higher than its 2007 high while Disney (NYSE:DIS) is trading almost double the price from its 2007 high.
The long term chart comparison is my first filter.
This step takes less than 30 seconds and it is a way to quickly filter which stocks are worth analyzing.
Remember that time is one of your most valuable assets. You need a way to quickly filter stocks and using a technical filter is much easier and faster than using a fundamental filter.
Borrowing strategies from evolution
I like to take lessons and strategies from nature. Learning from nature and animals offers us many advantages because nature did all the research for us by evolving over time. We simply have to look at the final product and borrow particular attributes that fit our trading strategy.
This is similar to a predator such as a Lion, It will look for the easiest meal and attack the prey that offers the best risk reward scenario. Don’t be a hero and take on the riskiest trades when you can easily find better low risk high reward trades.
Disney (NYSE:DIS) passes the test. The chart is clean (technically the probability to determine its direction is better than normal) and offers us more ‘pop’ than the S&P500.
Step 2: Understanding the stocks behavior.
Every stock has its own personality. It’s like you or me, the dog or the kids, everything under the sun behaves in its own manner.
Did you know that the stock’s personality is dictated by the people and computers that trade the stock. You don’t need to know all the people who trade the stock but you should know who are the main holders of the stock.
Disney (NYSE:DIS) is a popular stock that is 70% held by Institutional and Mutual Fund Owners.
Is it a good sign that the major financial institutions are holding Disney (NYSE:DIS)?
NO, it’s a neutral signal, well certainly not enough of a signal to buy the stock. The major financial institutions are not as smart as you think they are. How did your Mutual Fund portfolio do in the stock market crash? They got smoked. The proof is in the returns. Did you know that the average mutual fund under performs their benchmark average. Did I mention that Mutual Funds are obsolete and expensive financial products and that you should replace them with ETFs.
Disney (NYSE:DIS) is a large conservative Blue Chip company that is held (70%) by slow moving financial institutions and this usually means that the stock will move like a train or large ship. It will be slow in acceleration, take a long time to change direction but when it moves in one direction it will take a lot for it to stop moving.
Write that down and remember it. That is the reason why the chart for Disney (NYSE:DIS) is smoother (less choppy) than the S&P. That statement alone will dictate the type of trading strategy I will use.
Step 3: The Technicals and Fundamentals
Read the Disney article, I explained how the stock was starting to change behavior and is slowing down. It’s similar to a super tanker at sea that is slowing down in order to change direction.
You will also notice that the last major decline for Disney (NYSE:DIS) happened in the 2008 Stock Market crash. The stock stayed in a prolonged holding pattern and only joined in the massive sell off well after the S&P500.
In simple terms, IF Disney (NYSE:DIS) goes down they you’ll probably need the S&P500 to go down first and then Disney (NYSE:DIS) will play catch up.
If Disney (NYSE:DIS) goes up then don’t expect it to have the same acceleration as it did from 2009-2013.
Why? You shouldn’t expect big moves from a large conservative Blue Chip company. Disney (NYSE:DIS) behaved like a growth company and growth companies need increased earning to fuel the growth in its stock price.
How is a Leviathan suppose to grow its earning like a smaller, more nimble company? It can’t.
Disney (NYSE:DIS) is a good example of a Blue chip company that was IN-PLAY and popular. The IN-PLAY or popular group pushed the stock up and now the stock is waiting in NO MANS LAND.
I believe you have a case of limited upside potential and greater downside potential in terms of stock price.
This isn’t enough information to pull the trigger on the trade. We need more information to generate the exact risk reward trade set up.
Step 4: Using the last 9 months to create the trade set up
Let’s take a look at the 9 month chart of Disney (NYSE:DIS).
It took 4 months (Feb2013- May2013) for Disney (NYSE:DIS) to move $18 or 36% ($50 to $68).
The price has consolidated for the last 5 months (May2013-Oct2013) and has moved $7 or 10% ($68 to $61).
This is the simple technical sign we are looking for. We don’t need all the different price studies. Simple is best.
Now let’s look at the news.
Search the news events for Disney (NYSE:DIS) and you’ll see these headlines:
‘Disney, One of the most loved stocks in the S&P500’, ‘Eye-Catching Stocks’, ‘Disney planning to buy back $6-$8 billion worth of its stock’.
Here’s a quick lesson on news.
People are very positive about a stock near the top and very pessimistic about a stock at the bottom. Why is that?
It’s human nature. Think about fashion. When everyone wants the latest hottest thing then that thing loses its appeal and slowly goes out of fashion. The same thing works for markets.
When a stock has been bullet proof (mostly going up) for the last 5 years and then things change for whatever reason, then all of a sudden it can’t go up on really positive headlines, that is a clue that the stock is not as strong as you think it is.
Step 5: Let’s look at the latest market action
We are seeing a fractal pattern. What is a fractal? It is a self-similar pattern on different scales. In this case, the 5 month holding pattern is showing up on the 1 month holding pattern. It’s a pattern on top of the same pattern.
It took 7 days for Disney (NYSE:DIS) to move $7.5 ($60.50 to $68) or 12% and the last 12 days to move $1.50 or 2% ($64 to $65.50).
So we are getting weaker on the 1 daily chart and weekly chart.
Step 6: Putting it all together.
We know that for Disney (NYSE:DIS) moves very slowly like a super tanker and the moves tend to be on the clean side.
We also know that Disney (NYSE:DIS) tends to move in 1 direction once it starts moving in that direction.
We also know that Disney (NYSE:DIS) is showing us a change in price behavior, an upward market that now is going sideways.
We also know that Disney (NYSE:DIS) cannot continue to accelerate its earnings growth potential and that means it has limited upward price potential.
We know that the ATR (average true range is measuring tool Quants use to measure volatility) is about $1.
Here’s the trade:
Short Disney (NYSE:DIS) when the following conditions are met:
1. Disney (NYSE:DIS) price close is below the 50day moving average and below its latest 12 day price consolidation.
2. Disney (NYSE:DIS) also trades at least 1 ATR ($1) below condition #1.
Take the SHORT around the $63 level. Remember that the price is above $63 right now and we are not taking the short until we get to $63. Don’t get greedy on the price. We want short term momentum to be on our side as we make this trade.
Do not short it above this price level. There is a chance that the price goes higher from here.
Target 1 for 1/3 of the position is the 200day moving average: $60.50 price area.
Target 2 for the next 1/3 of the position is the $53 price area (the Fibonacci 38.2% retracement from 2011).
Target 3 is undefined.
STOP: will be 1 ATR ($1) above the high ($68): $69
Risk: The risk is about 9% if you get stopped out without hitting a target.
Note: We will be changing the stop if target 1 gets hit. We will try to put this trade into Theoretical Risk Free Status as soon as we can. Our intention is to take advantage of short term volatility and leverage short term momentum that into a ‘Risk Free’ longer term trade.
Target 1 (1/3 of the position) ($60.50) will most likely get hit if we close below the $63 (our short target price) price level.
Target 1: 4%
Target 2: 16%
Do you go through this type of process when you make a trade?
I’m guessing not.
That is why I created Profit Behind The Blog.
This is the best way for you to learn how to trade and we do it in real time so you get to see how the trade works out.
This is how we trade in the Hedge Fund world. A lot of work goes into the trade preparation. The easy part is the execution of this game plan. I know my loss potential (9% ish without GAP risk). I know 2/3s of my profit potential (4% on 1/3 and 16% on 1/3)
For information regarding stocks we do like, check out our Flagship Newsletter.
This is a cursory look at Disney (NYSE:DIS) and we are not making any specific buy or sell recommendation but merely voicing our opinion of the current situation. Each individual investor must conduct their own due diligence of both the company, the market sector as well as their own financial situation and risk parameters.
If you ever find yourself second guessing your every move, summon your inner Brett Favre and just make the damn play. Follow your strategy and learn from your mistakes. In the words of Tony Montana, The World is Yours!
Originally published at BehindWallStreet.com