The Bounce Trade (Final Thoughts)

By definition, the duration of a bounce trade is intended to be very short term. You are usually only looking for a one or two day move that allows you to either rake quick profits or to get out without losing much capital. If you are fortunate, you will catch a bounce that has more strength than expected and takes the stock back above (or below) the original peak. This is not common and you shouldn't enter the trade with that as the objective, but it does happen on occassion.

The Exit
To make a good bounce trade, you need to enter the trade with the expectation that you will be proved right or wrong within a day or two at most. By timing the entry, you have put the odds in your favor already, otherwise you wouldn't be in the trade. The key is to keep the odds in your favor. To do that, you have to execute your plan with precision and without second guessing your moves. This is most important with respect to your stop. When you enter the trade, you have determined what your defined risk is and based upon that risk and your potential reward you have decided the trade is worthwhile. If you do not exit at that defined risk point, then you have changed the equation. As a result, you must place a stop where your defined risk is and not waver if the price goes against you.

On the profit side, again this is a bounce play. The high percentage of bounce moves will never reach their previous highs (or lows) within the time frame you have for this trade. If, after having entered the trade, you find that the stock is moving strongly back to the direction of the trend, you may decide that taking profits at your defined profit area doesn't make sense. Even if it appears this way, you must take partial profits at a minimum. By taking partial profits (I usually take half), you guarantee yourself of a winning trade while allow the opportunity of a big win. You can bring your stop up to your entry point and allow the rest of the trade to run. If it comes back and stops you out, you make half of what was originally planned. If it keeps moving in the direction of the primary trend, you have the luxory of taking profits at a higher point. In most cases, however, you will not see the bounce accompanied by enough volume and strength to make you want to stick around and thus you will take profits at your defined exit point.

The more usual case is that neither your defined exit price (win or lose situation) isn't met yet your time frame for the trade is expiring. When that happens, as was the case in the example GLD, you have to close out the trade and take whatever loss or profit you have. It is inexcusable to stay in trade once it exceeds your predefined time frame unless it has performed far better than you expected. In all other cases, you must exit.

Summary

The bounce trade can be a very profitable trade given the amount of time that you are in the trade. It is centered upon the notion that prices eventually revert to their mean. When a stock (or any tradeable issue) has parabolically moved away from it's mean and then has recoiled quickly in the opposite direction, the bounce trade becomes and option. By timing entry and exit while religiously respecting the timeframe for the trade, the bounce trade can become another tool in your trading war chest.

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