The Five Phase Trade
Phase One (P1) – The Build-up
The first people in a position to have knowledge of sensitive information will be the first to start buying a stock. They often do this in a deliberately unobtrusive manner so as not to move prices upwards until they have accumulated sufficient stock. I call this period “The Build-up”.
The build-up is a period during which prices are confined to a sideways trading range bordered by a resistance line as shown in the chart below.
As can be seen from the chart above there is a horizontal resistance line P1 covering over three months of data. This resistance line is more a price resistance level than a resistance line. A true resistance line should be drawn across at least three common price points. I also prefer to see a horizontal resistance line rather than a downward sloping resistance line.
On the six days prior to break of this resistance, the traded volumes were:
Day 6 2,000,000
Day 5 300,000
Day 4 1,800,000
Day 3 750,000
Day 2 7,100,000 – a big leap in volume
Current day 6,100,000 – good follow through volume
Order placement takes place during “The Build-up”. Fine tuning the entry can be done by correctly interpreting the market depth.
Market depth gives you a snapshot of some very important pieces of information:
- the number of buyers and sellers;
- the number of shares wanted;
- the number of shares offered, and;
- the prices at which people are happy to buy and sell.
Market depth is available from all internet trading platforms. In the case above we can see the various numbers of buyers and sellers and the number of shares for sale and the number wanted. This is a snapshot of market depth at one specific moment in time. Market depth can fluctuate every second as further buyers or sellers join the bids and offers. The example above is exactly what we are looking for when trying to find a stock that is ready to break through resistance. The table shows buyers, sellers and volumes 20 deep. I ignore all but the top five.
If we add the top five buyers in the example above, we have 160 buyers wanting 10,710,316 shares. On the sell side we have 79 sellers offering 5,178,139 shares.
So, there are twice as many buyers as sellers wanting twice as much stock as that being offered. Logic tells you that this stock is very likely to rise in price. While there are no guarantees of a price rise because there may be large sellers who have not placed their orders, the odds are certainly in your favour.
Getting the timing right for a 5 phase trade
What you are looking for is a situation where you are in a build-up phase with prices consolidating below a resistance line. Once you recognise this phase you are looking to place orders so you need to check the market depth each day.
This is best done each evening! Do not check market depth just prior to the market opening. Numbers just prior to opening are notoriously manipulated. Traders who own stock and are trying to boost the market, will place a buy order prior to the open in an attempt to bolster the numbers, and make it look as if a lot of buyers are coming into a stock.
Moments before the open they will cancel these orders. You may cry foul over this deliberate manipulation but it is far better to know that it happens, to understand why it happens, and perhaps turn it to your advantage at some stage.
For the purpose of the “Five Phase Trade”, we just need a snapshot of the depth in the evening, when all is quiet and well prior to the open. We are looking for the depth to turn in our favour, i.e. far more buyers than sellers, wanting far more stock than is offered. Look for the number of buyers to be double the number of sellers, and to be asking for twice the amount of offered stock. This is critical. When you have this situation it is safe to place the purchase order “a tick” above the resistance level. A tick is the smallest allowable price increment.
Phase Two (P2) – The Entry
Once the price breaks through the resistance, your order to purchase will be transacted. This could happen the next day or quite some time after placing the order – be patient.
If you are watching the trading session on a live trading platform, you now need to place a protective stop loss order. In the case of the chart shown below, the stop loss should be placed below the low of the Phase Two day marked P2. This stop loss should be placed as soon as possible to reduce the risk.
On occasions the market will “gap up” and the opening price will be above the resistance line. In this situation the protective stop loss should be placed a price tick below the resistance line. Once a resistance line is penetrated it usually becomes a strong area of support. We can see the gap upon the open in the chart below.
If you are not watching the market, the placement of a stop loss becomes difficult. In practice, you have a buy stop or a start gain order placed. This order may sit for a week before being filled. Most people are at work and not able to watch the market on a minute by minute basis and generally this is a good thing. If this is the case you may not be able to place the stop loss until after the close of the Phase Two day, before the open of the next day’s trading. If this is the case for you, then there is little you can do about protecting your position during trading on the Phase Two day.
In preparation for Phase Three, stops need to be placed pre-market a price tick below the low of the Phase Two day.
Phase Three (P3) – Wait and see
The Phase Three day occurs when the stock price moves above the high of the Phase Two day – marked as P3 on the next chart below. This could happen the next day or several days later. It is usually a very strong day with high volume and a large price range. From the trader’s perspective there is nothing to do other than sit back and wait. The stops have been placed so it is a “wait and see” day.
At the end of the Phase Three day place your stop loss order a tick below the low of the Phase Three day. If the market does not follow through, the stop loss will protect you.
Phase Four (P4) – Exit
The Phase Four day occurs when the price moves above the high of Phase Three – marked as P4 on the diagram above. Of course you need to be watching the market to know when this happens. Alternatively you need to receive notification that the high of day three has been broken. There are several choices when it comes to exiting the market at Phase Four.
1) If you are watching the market you will know when the Phase Three high is broken. You may now choose the sell “at market” at any stage during the balance of the trading session.
2) My preference is to sell near the close of the day.
3) You may see the market depth shift in favour of the sellers and sell as this occurs.
4) If the market “gaps up” you might take advantage of the sudden leap in prices and sell immediately.
Regardless of how and when you choose to take profits I strongly recommend that it is done at some stage on the Phase Four day.
Variations – “Inside Days”
As with all aspects of trading there are variations and unforseen events. As a trader it is our goal to allow for all these variations. One simple variation is the “Inside Day”. This is a day where neither the high nor the low of the previous phase is broken. In my Five Phase Trade rules I discount inside days. In the example below, the Phase Two (P2) entry day high and low were not penetrated during the next two days. I count these days as part of Phase Two. In other words the high of Phase Two needs to be broken before you get to Phase Three.
We can see in the chart below a situation where Phase Three, in fact, lasted 18 days until being stopped out.
With an entry at 5.1 cents the stop loss would have been triggered near the 10 cent level. So this “failed trade” still doubled your money in a couple of weeks.
Variations – “Price”
I have mentioned that my preference is to trade stocks priced at less than ten cents. If you feel these stocks are too speculative for you then there is definitely no reason why you wouldn’t use this trading method to take advantage of sharp moves in higher priced stocks. The LNC trade is a classic example of a very successful trade that started at the 30 cent level. Notice in the chart above that P2 did not happen on the small break above the resistance line. This is because we did not get the transaction filled until the next day.
- The Five Phase Trade ensures your funds are not tied up for lengthy periods of time in stagnant stocks.
- Provided you have the discipline to follow the rules, this method of trading is great for building a small account into a larger account in a short period of time.
III. If you can read the signs, I feel that “trading” these spec stocks is no more risky than “investing” in the so called “blue chip” stocks.
- This style of trading is fun! Many experts will talk about the emotions of greed and fear and go into all sorts of details about controlling your emotions. Very few mention that trading should be fun. Yes, it is nerve wracking at times, often frustrating, sometimes downright annoying, but never boring. Any form of investing should be fun.
- The stocks trading at less than ten cents are often only a heartbeat away from bankruptcy or a capital raising so trading these stocks are not for the faint hearted or for those who do not have a very good plan or the discipline to carry out that plan.
- Even then, having the best plan in the world is occasionally not enough to save the trader from taking a nasty loss. This is the main reason for not putting all your funds into one trade.
III. Capital raising by companies is most prevalent during a bull market. The general public is always vulnerable to a company that needs to raise a few million dollars to develop the latest gadget, pursue a new medical cure or dig a hole in the ground.
When you have limited capital it is particularly annoying to be caught in a capital raising where the stock price may not move for weeks or even months.