Since mid-March 2009, we’ve had a bull market. Those willing to short have taken their lives into their own hands. Even a lot of smart money was lost with the Gamestop short squeeze. Smart money rarely loses. We may be heading for a long-overdue bear market. For this reason, we’ll introduce the First Red Day (FRD) pattern, how to identify it, and how best to trade it.
What Is a First Red Day Pattern?
Do you know what a first red day pattern is? It’s any day close where the open is higher than the close is a red day. For example, May 10th opened at 422 and closed at 417. Then every day after is a red day. If you have black and white charting, it’ll be black. With an FRD, you want to see several days of green candles before it, then your first red day is a red candle.
This is an indication that the asset is overextended. Of course, even an index can get overextended. But we usually look for penny stocks that will react slower to long side overextension.
With quick runups, there may be lost momentum, fewer potential buyers, bears thinking the stock is now overpriced, or bulls thinking they have missed their buying opportunity. It also relies on some overhead resistance that is supplied by other traders who have held long through a downturn, and when they reach a certain point, they sell (usually if they are going to finally break even).
This is where a first red day pattern occurs. Bears begin shorting, adding resistance to reduce their risk, and if there is enough downward pressure, this may result in panic selling; the decline could be a multi-day drop to at least the next support level.
Identifying a First Red Day
We are looking for a stock that has a multi-day runup. So the more consecutive green days with high volume and large climbs, the better. Between 200% and 500% in total gains over the period and with a market cap under 500 Million, preferably much lower, from the start.
Don’t go for a 30 or 40% climb. You want to be sure of a first red day pattern. A penny stock that is up four days in a row from $1.25 to $8.03 fits the bill. Next, you want to find a day that ends lower but has resistance all day long.
A perfect double example was Genron $GERN.
From January it saw a run-up from $2 and a market cap of $325M to $6 and then drop back after a first green day that looked like this on March 26th…..
After the first decline, GERN saw a few pushes up in June to 5 but did not amount to anything. Then from July 27th, we saw a long runup and 11 straight days of green.
And a First Green Day pattern on September 11th. Where it had reached its previous high from the March runup, and those that had made bad purchases were going to break even. We are short at $6.05 with a stop on a quote at 6.50 (at the resistance level and less than 10% loss) There was minor support with decreasing volatility at $5.50 and push up to $6.40, but then with a minor press release, bam.
These support levels and a slight bounce were a potential worry for sure, and you may want to cover a position to prevent a short squeeze, but the decreasing volatility on the 24th was a good sign.
How Best to Trade a First Red Day Pattern
In general, stock prices go up, and the most a stock can lose is 100% of its value while the upside is infinite. Therefore, shorting stocks is a dangerous game from the start. If you’re looking for a First Red Day pattern and it coincides with a parabola with minimal selling and few buyers able to bring it higher you’re in a better position.
You want to see the parabola top off, and you will use that peak as your risk level; it is usually about 10% above your short price. An essential aspect of short selling is risk management. This is important for any trader, especially if you’re shorting.
Risk Management Rules
- The first rule of a first day red pattern is to stick to your plan. Chose a risk level you are comfortable with before going into the trade and stick to it. To deviate from this plan with emotional trading is an easy way to lose your shirt.
- Set up a stop loss at that risk level to prevent significant losses. Stop losses can save you when you have made a colossal mistake.
- Also, know the point that will close a position on the profit side and edit as the price falls lower. You can erase gains just as quickly if the stock bounces right back up without closing your position in time.
- Make sure your win will be bigger than your loss. This ratio will decide if you should open the position. In the case of a First Red Day, there should be an upside that is several times the downside.
- Patience plays a big part in success; only open a position that looks better than just good. FRDs are often more successful, with stocks having a market cap of less than 150 million. The reason being that there is significant potential for volatility; resistance will not be as strong nor as quick to react having fewer traders.
- Check your win percentage regularly. Keep finding FRDs if you are picking at a better than 55% and are overall profitable. If not, try your hand at something else.
For those that are willing to take the risk and short a stock, you can be very successful, but because stocks naturally go up and the downside risk is usually more significant than the upside gain, the odds are stacked against you. A first red day pattern is challenging to succeed with. So monitor your achievements (or lack of). As you learn more with experience, ask if you are improving?
The fundamental rule of nonemotional trading, setting and keeping to a plan, is imperative. Stay focused, and FRD may be your pathway to success. As always, Bullish Bears advise you to never put at risk more than you can afford to lose with a single trade. Good luck with all of your trading.