This is an example of one of the easier trading ideas from Mastering the Trade (McGraw-Hill Trader’s Edge). The author prefers to use this idea in currency markets, because he says they break out cleanly. But, as long as a stock is in a solid trend, I’m finding it works okay in the stock markets.
It’s really not too original an idea… plenty of books on chart patterns will show you a channel breakout pattern. I like the way Mastering the Trade describes it, though, because it emphasizes the importance of making sure the stock hits each trendline at least twice (and preferably three times).
Here’s an example of a box play on Companhia Vale do Rio Doce (NYSE: RIO) today.
Setup
Strong up move on strong volume in RIO, making new 52-week highs. Rising ADX on 60 and 30 minute timeframes.
Entry Criteria and Trade
I saw the box form on the 5-minute charts towards the end of the day.
- A local high is formed at 32.45. I draw the upper line.
- The stock reverses from a low at 32.14. I draw a lower line.
- The stock moves up and reverses from 32.43. Not quite touching the upper line, but good enough. Had it gotten a little higher, I would have moved the upper line up. Since it stayed lower, I leave the original 32.45 line in place.
- The stock dips down to 32.14 again, and reverses. When in retraces 25% back into the “box,” the trade is ready. I will short a drop below 32.14, and buy a rise above 32.45.
- The stock breaks out to the upside. I buy, and my initial stop loss goes at the lower line, at 32.14. My profit target is the same width as the box, or a 1:1 risk/reward ratio.
Profit target is hit a few bars later.
To read about this play and several others, check out the book. Trader Mike wrote a great review of it a while back, if I haven’t convinced you.
Have you looked at many potential setups with this? What’s the typical win/loss rate? A 1:1 ratio seems too small, but I’m “wrong” a lot :/
They seem to work with high probability, but I haven’t taken any kind of rigorous look at it, yet. I think the key is the 1:1 Target, because often the failed breakouts will at least run that far.
[...] The markets were kind of dead to me, today, with no real spectacular volume in my watchlist triggers. So, I decided to play more with the box play. This one was off the 1-minute charts, making it more of a scalp than anything else, on Thornburg Mortgage Inc (NYSE: TMA). [...]
[...] every time, unless there is something special about my thought process for the setup. Check out other examples of the box play if you are unfamiliar with it. Stocks Mentioned In This ArticleStockLinks RMBS | [...]
[...] Turns out, the trade would have gone very smoothly, and it came within 2 cents of the target price before closing at EOD about halfway to the target. Not bad for a trade that triggers after 3PM EST! I am really liking this box play… in case you can’t tell. For more about how the trade works, see for instance this box play post about another trade. [...]