I want to provide you with a simple technique that will allow you to take advantage of stocks when they experience a price pullback— this approach will help pinpoint when it’s time to be a buyer and get bullish.
“Buy the dip” is an expression that is set to describe a trader who has just bought shares of a stock that has experienced a sharp decline. The dip buyer believes that the selling pressure is overdone and that the stock is due for a bounce.
Of course, get it wrong, and it can be a painful lesson, a feeling some traders call: trying to catch a falling knife.
The problem with buying the dip is that you’re exposed. In other words, if you buy shares of a stock that just fell… and the sell-off continues, you could wake up with knots in your stomach and a feeling of disgust.
There’s a better way to buy the dip—one that avoids trying to “catch a falling knife”. In fact, I actually used this strategy to lock in a 49% return winner last week (in addition to 3 other winners from my Weekly Windfalls Strategy ).
It’s safer than buying the dip because it uses options to control the risk. And the leverage allows you to make big returns on small moves in large-cap stocks like Alibaba (BABA)
At the beginning of last week, markets were a bit jittery with all the political uncertainty and the trade war.
We actually saw some weakness in some reputable companies… and I actually saw that as an opportunity to profit.
If you look in the daily chart from Finviz, you’ll notice the blue trendline. If you look at the daily candlesticks, the rising trend is pretty well established. Every time, BABA made higher lows and followed that blue line pretty closely.
As a technical trader, the reliability of trends in large caps is much better than small caps. You see, BABA is a good company, and anytime there is an opportunity to buy shares on the cheap, traders gobble up all that edge.
In other words, large-cap stocks tend to hold true to technical analysis.
So the technicals lined up… and there was also a catalyst as well.
BABA took a beating with the trade war news and got dragged down by the market to the low $160s.
However, we knew Trump was meeting with China and I assumed between Tuesday when BABA touched that blue trend line… and the end of the week, it would bounce off it.
From another technical standpoint… BABA was trading in a rising channel.
If you notice, BABA has been trading between those two lines in the chart above… and I figured BABA would bounce off that lower trend line and trade higher.
So did I go out and buy shares?
No, that would’ve been a huge capital suck and I wouldn’t be trading efficiently.
Instead, I used a simple options strategy.
It’s what’s known as a bull put spread.
Basically, it’s a strategic options position that uses a combination of put positions to bet a stock will move higher.
All you really have to know is that in general, this strategy stacks the odds in your favor because you can profit in multiple scenarios:
– If the stock goes up
– If the stock trades sideways
– If the stock falls a little
The only thing that you really need to happen is for the stock to stay above a level.
In this case, I sold the $165 puts and bought the $162.50 puts (that was my hedge).
So that meant I was betting BABA was going to stay above $165 by Friday.
The position in the yellow rectangle is what you want to focus on here.
Since I sold the $165 puts, someone who bought from me was betting BABA would stay below $165. At the time, BABA was trading at $163!
But I figured the drop in BABA was an overreaction… and when people panic, I tend to see it differently… rather than letting the emotions get to me, I just follow the technicals.
Just by doing that, I was able to lock in $6,400 in BABA… and more than $20K overall using my Weekly Windfalls Strategy.
If you want to hear more about the trade and strategy, watch the recording of my Facebook live video from the other day!