Day trading is a very difficult profession. No, scratch that. Any kind of trading is a very difficult profession. It’s not that traders have to be geniuses, wealthy or tech gurus. In fact, the biggest battle is in our head. Knowing when to stop out for a loss, book gains and maneuver the markets is so much harder than we initially realize when starting out. But there’s one way to help: the red-to-green setup.
The longer we stretch out our trading horizon, the easier the game is. But the longer we survive the game, inevitably, the shorter the timeframe many of us start to use.
Day-trading has a negative connotation with it. Investors tend to think of day-traders as algos and prop firms, while non-investors think of it as swindlers ripping around on penny stocks. That’s not really the case, as you’ll see.
The red-to-green setup is actually quite simple, because the rules are so well defined. Much of trading is actually simple too, we just make it complicated by failing to stick to our plans. We let losers run wild, double-down on low-quality setups, trade with too much size and have poor entries.
Because of the simplicity of the red-to-green setup though, traders can map out of a firm plan and actually stick to it. Here’s how it’s done.
The Red-to-Green Setup
The first step? Finding candidates. It’s key to find stocks that performed well in the prior session.
Twitter’s @TraderStewie does a great job talking about his “Power Earnings Gap” trades. In fact, he even keeps a public list available, for free. These are stocks that move well on earnings.
For trading red-to-green setups, this type of price action is ideal. However, it doesn’t have to be an earnings rally. It can come off an important announcement, investor meeting, ruling or another key development. Although, M&A doesn’t tend to work as well.
The point is, we’re looking for something that moves well and closes strong on the day. That’s step one.
*Tip: I prefer to look for stocks that have a market cap in excess of $2 billion and average more than 1 million shares in volume per day. Feel free to alter it to your preferences, but I find it works well for me.
After we find a viable candidate, it’s time for Step Two. That is, looking for a slightly weaker open in the next session. I generally like an opening loss of less than 1% to 1.5%. The total loss is important, but we’ll get to that in a minute.
Here is the strategy: If we have a stock that closes strong in the prior session, but opens slightly weaker in the current session, we have our candidate for a red-to-green setup. We’re looking for the stock to go from a lower open and reverse to positive territory. Once the stock goes from red to green, that is our entry. In other words, our entry is near the prior day’s close after a lower open.
When a stock opens lower on the day and quickly turn positive, it shows that buyers are willing to snap this name up yet again, even after the prior session’s big gain.
Here’s why the total loss is important: the stock’s session low becomes the stop-loss for the trade. That’s how we measure the risk and determine if it’s a worthwhile trade. It’s simple, black-and-white risk management. There’s no “gut” feeling or head-calculations to worry about.
We want a decent (but not huge) opening decline so it gives us a level to measure against. If the decline is too shallow, it makes for an easy position to be shaken out of.
An Example of This Day Trading Strategy
I loved the way Dollar Tree (DLTR) stock traded when it reported earnings in March 2019. We had a gap-up start to the day, where DLTR actually pulled back to the 50-day moving average. (You can tell its action by reading the candlesticks).
That 50-day moving average held like a champ, as Dollar Tree stock reversed and closed well on the day. It also closed over $100, which was a very key level we were watching (as highlighted on Twitter).
You can see on the chart we had our “big move” on earnings, but shares opened lower on Day Two. On the second day, the stock opened near $99.50, dropped to ~$99 and reversed higher. Once it went green on the day — so around $100.40 — that is our entry on the long side. Our stop becomes the session lows, or ~$99 in this case.
This trade was a textbook red-to-green setup.
Final Thoughts on the R2G Trade
You’ll need to use your judgement or set your own rules for an upside target.
But the most important part is that we have a limited-risk, defined entry system in the trade. From there, we can manage the trade to be a swing trade or a day trade. If we get a decent gain — say +1% — we can raise our stop to break-even to ensure we don’t lose money. Different approaches will work for different traders, but at least we have a system in place.
I personally do not like to let a stock drop more than 2% on the day. The reason being, I don’t want to risk more than a 2% loss on a day trade, which the red-to-green setup typically is for me.
In the event where a red-to-green setup looks quite attractive to me, but the losses exceed the 2% threshold, I will consider an entry but with a smaller trade allocation to account for the potentially larger drawdown.
In any regard, this is just an idea to help form one strategy for you guys! Hope you like it and feel free to alter it to your preferences. It’s just educational after all. Happy trading.