Attack Of The Drones
A review of the DRO climax trade
The best traders have the ability to swing the bat and execute when it truly matters. They make their month and even year in a few choice moments.
It would do me good to let that message sink in.
There are special situations when a major force pushes a stock to extremes. These occurrences are rare, the historical background disappears, and you are left with an asymmetric opportunity.
The Australian market witnessed such a moment last week in Droneshield (DRO). After months of watching US stocks present one crazy opportunity after another, we finally had our “SMCI moment”.
In this post, I want to reflect on the build-up to this trade and go deep in review. I saw some guys put up huge numbers on this trade which was truly inspiring. Unfortunately, I did not maximise this at all. No excuses.
All I know to do in such situations is study, practice, and internalise key lessons. Hopefully, this post will help you in a similar vein.
An Announcement
Before I go into depth, I have big news to share- I will launch a member’s service next month!
Details of the offering are to follow but it is these exact reviews that I will share on a more regular basis with readers. The people have voted and the overwhelming feedback I have received to date is for more trade write-ups.
Of course, some specifics will remain private. Edge erosion is a real thing in a small market like Australia. However, I believe general concepts are extremely valuable and can be reverse-engineered to tailor the individual. I want to write about liquid directional moves that carry a low risk of edge decline. It is those structural inefficiencies, glitches, and quant-based models that involve a much higher risk.
The reality is everyone trades differently. Even armed with the same information, results between traders will never be the same.
I am excited to explore this opportunity through my writing. Stay tuned.
The DRO Build-Up
Patterns are universal. Trading lessons are universal.
Mean-reversion trading is not a style of trading that comes naturally to me. I am a momentum junky at heart who goes WITH the catalyst and with the flow. However, I was privileged to witness a US-based trader crush extended stocks over and over again. Here was the proof that not only was it possible to fade stocks, it was hugely profitable. No self-limiting beliefs.
The most important concept is “waiting for the turn”. With an extended Daily chart backdrop, you need to see a true climax event in both price and volume to indicate trapped participants. It is a meaningful move lower from these extremes that confirms this turn. The Daily chart and intraday chart must align. This is the formula to avoid recklessly fading which is one of the biggest sources of losses that I observe.
Despite different markets and microstructures, similar repeatable patterns were observable in Australia. With the help of quants and other traders, I was better able to reverse-engineer these setups with specifics.
What I found in my market was that stocks very rarely made these clean intraday capitulations and turns. During the day, strong trends would often turn into a choppy mess or there was a very real risk of an intraday halt. Instead, given the timezone, it was pent-up demand or supply from the overnight session that created the true inflection points.
This is the prelude to the DRO setup.
Not Ready Yet
I would be lying if I said I didn’t have a few stabs at this trade on the way up. However, DRO just wouldn’t crack.
This is powerful information in itself. A stock that cannot turn lower despite overbought conditions is a sign of major strength.
These are not the trades for stubbornness as they are extremely high risk. You can find yourself fighting real money and momentum. I have the war wounds from LKE in August 2022 fresh on my mind. Make trading easy and not hard.
In early July, we had a run-up on the daily chart that started to fit my extension requirements. I then dropped down to the intraday timeframe to execute for a possible turn.
4/7/24:
I shorted 1/2 my size early and then the rest on the breakdown through the open. The initial move above 2.00 failed, and then I saw volume into the bids with real flow. This is exactly what I wanted. However, 1.90 dropped and rebid. It held on the retest. The recovery was a lot stronger than anticipated and I was forced to cut the remainder into the close. A nice early win became a small loss.
10/7/24:
In the following days, a similar scenario presented itself. I thought this was an even stronger play. I sold out longs and went short on the turn. I tried to build into size on the true breaks but each attempt would often lead to a squeeze. The pattern was very messy with no strong reversal lower.
DRO Daily:
This chart shows the daily backdrop on both intraday attempts.
These were short trades with positive expectancy that just didn’t play out. Sure the hindsight “easier” trade was just to be long on the way up. However, this is a different game.
It was the repeated strength in the following days that sucked in even more money leading to the true sweet spot.
The Trade 16/7/24
Gap-up fade and Daily climax
-Catalyst:
No fresh news but multi-day momentum higher that had juiced in new longs and retail orders. Commsec no 2 on GROSS flow with $100m from 8th July to 15th July.
Stock indicated at 273 on 3.5m shares in Germany.
A bearish note was released pre-open from Capital Brief.
The daily chart is ridiculously extended on multiple metrics.
-Variables:
Strong run-up prior day closing +11%.
Gap up of 4%. It is these gaps that create the air pocket.
Extension outside of Daily boll bands with 2 wide-randing daily bars prior. Some of the strongest moves to date.
New retail bids coming in e.g. 190k at 296; 70k at 270; 160k at 267; 395k at 260. I haven’t seen retail this order flow setup since COVID markets! These are the spots to cue orders into.
Market cap $2 billion on $50m revenue and loss-making.
Management has sold out shares and options. Retain various options linked to revenue targets.
-Execution options:
Gap up and break open on volume. Hardest to get filled but the best trades go from the start.
Gap up, dips through open, recovers to trend higher before a turn. Most tricky scenario.
Gap up and drive higher into a parabolic climax.
Most unlikely given the extension: Gap up and just keeps trending higher all day.
-What did I do:
Open Volume: There were 1.5m shares on open or $4m. Instant drop through 2.71.
Entry: 1/2 vwap first 10mins and then 1/2 on the turn. However, the stock dropped within 1min and my vwap order went out of the limit. I thought there was a risk of a flick up through the 2.80s like in some previous examples, but this didn't eventuate. I had to then enter orders into the liquidity breaks e.g. 2.67 and 2.65 as it went very quickly.
Grader: A/A+
Size: Planning for 150k-200k min. Mentally thinking about a 10c+ stop given the ATR and the nature of the book. The Jugular would have been 300k. This was easier when the depth got tighter into 2.50s. However, I only got just over 100k given my vwap went out of the limit and I didn't adapt well.
Max offside: 0 cents
Adds: 2.60 and then 2.50 on the consolidation breakdown.
Exit: my rules are 1/2 into extension and then 1/2 vwap to close. Just committing to that 50k core would have been huge! Instead, I covered 1/2 into 2.55 at 11 am as per rules and then all into low 2.40s on the first breakdown. In an act of madness, I tried scalping long with the expanding volume bars but knew this was wrong, so I cut. Just dumb as you don't want to be fading Day 1 on a break like this.
Exit notes: The bounce out of 10.30 am was weak. The subsequent breakdown now needs new TIME. This is the key to the whole trade. The previous range was from 10.35 am to 12.06 pm. All the hard work has been done and it’s time to get paid. You now need to hold new shorts for a set time. If I had done this for a core, then I would have been looking at a capitulation moment into 2.20s vs my 2.40 exits. I let previous fading experiences in this stock influence me in a “see profit take profit” mode, but the reality is this was a bigger trade given the daily extension and build-up of new trapped money. Huge vacuum underneath with 30m shares+ caught at 2.50 or better over the past 2 days. There were attempted turns out of 2.30 at 12.25pm and then a clear turn from 2.00/2.05 at 12.50 pm. That would have been an A+ hold. The book looked so weak and felt like it could keep going.
See it moment: Breakdown through 2.50 on 438k or 5% of the day. Stale bids down through 2.45 and trapped longs from the last few days. Just couldn't bounce more than a few cents. So much volume down to 2.40 and the seller is real. Looked clear on the tape and pure panic liquidation.
Further Notes: the early action did not look to me like it was truly on. We gap up but no initial spike sucking people in further. Instead, we instantly drop. The book would recover, but it could not get back above the 2.60 volume drop which was the first key step. Volume soon dries out and it feels quiet/choppy with some bounce attempts. This was like previous examples in July where it wouldn't break, and this put me off. When we finally broke, I was quick to cover in a "see profit, take profit" mode. In fact, this is the true see-it moment. That one volume bar is huge. We are now truly backside. We have sat for 1hr+ and can't bounce. The R/R is just so good here. The breakdown looked so clean on the tape. It felt so weak and I felt like adding back on several occasions. This is what you want to see. Think about the vacuum and trapped longs above.
Notes on the breakdown:
Daily:
-Better next time:
Risk: Given the magnitude of this opportunity and how rare it is, I needed to think broader here. $30-50k risk opportunity. This needs to be sized EXPONENTIALLY. This is a 3 to 1 R/R. Very high win rate based on my past stats and examples e.g. BRN, CXO, ZIP. The ATR is 15c at worst if it got parabolic from that open. The stock was liquid enough to size well early and pyramid in.
Sizing: 100k+ adders, 150k initial core. I think 200k at the start of the day was the right number with 10c stop and then build to the jugular of 300k+ through pyramids. Can tighten up stops to 5c/7c on the 2.50 break for the very best risk/reward.
Management of trade: exit management was appalling on the 2.50 break. This was time to get paid. Needs time and price. Huge vacuum underneath with 30m shares+ caught at 2.50 or better over the past 2 days. 50k core open to close as per rules was A+. Of course, it is fanciful to think I could have foreseen a move like this and hold a core all day open to close. This was an extreme move. However, the stats of similar setups all show bar closes on lows. If it is a true capitulation, don’t pike the exit.
Moist Mango:
“"If this confirms and it is the unwind day, then piking the hold time isn't acceptable. It is so likely to do a deep unwind on the day and then subsequently gap down the following day.... this part of the execution isn't really up for negotiation"
In Conclusion
What I did well:
Didn’t take any drawdown on the way up into the climax. In fact, I was making money on the upside with my momentum-long system on each new signal. I also had 2 successful fade attempts, but this was not the true climax event.
Despite not getting my idealized early fills, I took down and had orders in the book below. I was patient early.
-Mistakes of points of tension:
I didn’t assess the true EV and risk-reward of this trade. What’s my worst case here? 10c? 15c? 20c? The payoff is huge versus this risk. Was too cute off the open.
I didn’t contemplate a core or an open-to-close vwap exit as per the strategy rules.
Piked the hold on the 250 break. This was the see-it moment and time to get paid. Done all the hard work. Time confirms the price and cannot bounce. Volume drying up and sellers unfulfilled.
It’s all about the vacuum underneath. Think broader about the sheer size of new participants caught out and the forced liquidation below.
Needed to better game plan the different pattern scenarios