A couple of years ago, I added a trading setup to my playbook that I call the “ATR Bounce” trade. First, ATR stands for average true range and measures the average intraday volatility of a stock (official definition here). The way that I trade primarily involves trading stocks that have a fresh news catalyst and that are gaping up/down on above-average volume (i.e., In Play). When a stock is In Play, it generally moves a multiple of its ATR. I have found that a 2-3x ATR multiple is a good rule of thumb intraday, although I have seen stocks move more than 3x their ATR (e.g., small cap biotechs). For example, lets say stock XYZ has an average true range (ATR) of $1.25 and is In Play for the day. Based on its ATR, it would be reasonable to assume an intraday range $2.50 (2x ATR) to $3.75 (3x ATR). I actually consulted with the guys over at SMB Capital a couple of years ago and they were generous enough to have one of their quants run a backtest on this trading thesis (post here).
I will incorporate ATR into my trading in order to help determine the probable intraday range of a stock as well as the likelihood of certain support or resistance levels getting hit, but that’s a topic for another blog post. As previously mentioned, what I would like to focus on in this particular post is an intraday, counter-trend long trade that I have in my playbook called the “ATR Bounce” trade. The criteria for this setup is as follows: 1) Stock is In Play (gaping up/down at least 3% on above-average volume and preferably has an average daily volume over 1 million); 2) moves 3x its ATR intraday; 3) stock is near long-term support; 4) intraday price confirmation. By definition, this trading setup is a counter-trend trade since the stock will have moved down intraday by an ATR multiple of 3.
I think the best way to illustrate this trading setup is with an example.
H&R Block ($HRB) was In Play on Friday and gaping down 10% after missing revenue estimates. Midday on Friday (3/4/16) I sent a tweet out that I thought HRB had likely seen an intraday bottom. As you can see from the chart below, the stock never made a new low afterwards. I said this after having caught the short on the open.
Think we’ve likely seen the lows in $HRB for the day… #Intraday
— Jake Huska (@MarketPicker) Mar. 4 at 12:17 PM
The reason that I made the above comment was because the stock met all of the criteria from above. According to Finviz.com, the average true range of HRB stock prior to today was 0.68. A 3x ATR multiple would therefore be $2.04. The stock opened at $29.27, so a 3x ATR move would thus be $27.23.
Now, before moving on I would like to emphasis that I don’t necessarily use ATR as an exact measurement but rather as an area to watch. As outlined above, one of the factors in this setup is the stock is coming into longer term support, which HRB was; as you can see on the daily chart above, $27 was a longer term support level. The fact that the stock was coming into this longer term support level and had moved 3x its ATR increased the possibility of an intraday bottom and potential intraday reversal.
As the intraday chart above shows, the stock held the $27 level multiple times. After seeing the multiple holds above that $27 level, I got long at $27.03 with a stop below $26.90. My first target was VWAP, which was a little above $28 when I initiated my long position, so I viewed this as a low risk setup.
Perhaps you will consider adding this setup (or some derivative) to your trading playbook.
Thanks for reading. Please let me know if you have any questions or comments.