BTD- you sure you wanna do this?

Lithium gap down playbook 6/12/23

The joys of B.T.D

There is a gravitational pull to Buying The Dip amongst traders. Stock is down, must be overdone right? No doubt Equities have gone up over the long term and it is a strategy that can get paid in the right cycles. Money is predominantly managed in Australia by long only funds who just cant help themselves when shares are being offered at a discount because “value”. Enter Australian Super. However, if I can think of the biggest landmines and the most disastrous risk/reward trades out there for short term traders, it is right here. I’ve seen it time and time again when a stock is cratering, extended from vwap and traders rush in to buy only to be met with more selling. You will hear comments like “news?” “swing?” or “now?” on each tick up which are all cries for help as the selling continues and the red in the account deepens. Invariably these trades start off small and then they get bigger and before you know it you are holding a position way out of whack with where you started because it is just “down too much". Welcome to BTFD. My example is for all to see in SYR when I started buying into the sharp sell off on October 24th and it just kept going. Another donation to the market.

The reason why these trades are so hard intraday is because you are fighting the flow. You are backfoot and not going WITH the said catalyst or that flow. You are reacting rather then being front foot. If a stock is still down a lot post 1pm and hasn’t snapped back, it is probably a really good tell this thing is not going to bounce.

Dont get my wrong as I have seen many traders make this trade work and it suits their personality. I think the truly expert players who make this trade work have found some real structural inefficiencies and glitches. I will not give specifics or examples as that really is edge erosion. However, they have a real tech edge. They have a access edge. They have the personality to take it on.

As I mentioned in my previous Playbook post, I do think it is really important to be open-minded. You want to be in a framework to receive opportunities and meaningful information rather then being closed book. The old me was cynical and argumentative but now I really try to sit on those feelings best I can. The unresolved issue I always had was mean-reversion trading (BTD/STR). It seemed like a flawed strategy to me but there must be a way to make it work. This is where I met a gentleman called Lance Breitstein.

Lance connection and reverse engineering

My mentor sensed my inquest and quibbling with this style of trading so he partnered me up with a senior trader who traded exactly the opposite style to me. Not only that, but he was hugely successful and made capitulation trading look so clean. I was the momentum trader shorting new lows (and selling the low tick) whilst Lance was picking off bottoms every single day. I would read his report cards religiously and saw the same trade play out time and time again in the US market. The problem was that these kind of patterns just didn’t work in my own market consistently. It was very rare to see a stock make a sharp sell off and then V reversal that very same day. Invariably it would just keep trending or flatline with the real reset coming overnight. I backtested a number of variables and just couldn’t get there. It also just didnt suit my personality. Eventually I stumbled upon a mean reversion system that looked to take advantage in the following days post a original move. It was the overnight gap and pent up selling that actually created the true capitulation and turn event in Australia. This was particularly the case during that COVID market when we saw huge intraday sell offs, a overnight gap lower, and than a complete reversal and melt up. It was a perfect time to implement this new system. Overtime I have had alot of help from a Quant team and other traders to make this strategy better and more systematic.

Yesterday was also a real good example of this trade and hence the title of this post. Note this strategy is very rare. It has a lot of nuances e.g. I don’t want to be fading major news events and I don’t want to be fading if previous day has huge RVOL. There are also a lot of nuances and variables that I just cant share. The point really is to give you an insight and perhaps there is something of value to you. It is just one of my playbooks. When it does line up, it can be very powerful. As ever, I would love any feedback on what I can do better and possible additions.

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Lithium Gap Down 6/12/23

-Trade name:

• Gap down playbook and Daily climax

-Catalyst:

• Lithium Futures limit down overnight. This is a second day in a row of limit down AFTER falls of approx. 30% in the last month or so alone. Futures curve decimated.

• Over weekend (Friday US time), the US department of Treasury issued further guidance on Foreign Entities Of Concern. Critical minerals cannot be extracted, processed, or refined by China. FEOC influence on entities involved in each stage is limited to under 25%, whether shareholding, board numbers, or voting rights. It was unclear to me the exact repercussions other than those companies seeking DOE funding and eligibility for IRA's clean vehicle credits. However, the circulation of this announcement did lead to very weak sentiment and selling in names with JV exposure or offtakes with China partners e.g. IGO, MIN, CXO on Monday and Tuesday.

• On Monday 4th December, UBS downgrades PLS to SELL and huge cuts to their Lithium price deck. Major Broker and mover of the market. Stocks sold aggressively on this.

• On Tuesday, the Futures exchange set new limits for the Lithium contract by increasing fees and reducing no of contracts allowed to be traded by non-futures company members. Attempt to calm the panic but again often heightens concerns.

• The open to close moves on 5/12/23 were huge for underlying ASX stocks: LTR -8.18%; CXO -8%; PLS -6.38%; IGO -4.95%; MIN -1.68%. The close to close move in PLS was -8.5%.

• This is all important context and background factors for the capitulation event. It is not fresh news but multi days post. I also dont think they are game changing events but pure sentiment.

• Lith ETF overnight was -2%. ALB -5.6%; SGML -6%. Not that weak versus our names previous day.

• Futures across the curve at Tuesday 2.30pm limit down. 2402 to 2409 all -9.99%!

-Variables:

• Stocks closed outside of Daily boll band e.g. IGO, PLS and LTR.

• Strong open to close move previous day more than -3% in LTR and PLS. Stocks indicated -1% or more on open. Extension from short term mean by X%.

• 3 days down on open.

• Daily volume elevated and 2x prior bars and 21d average.

• PLS shortbase 20%; LTR 6.22%; MIN 4.47%; CXO 11.5%.

-How to structure trade:

• Candidates: The ONLY true candidates based on my criteria of previous day weakness and gap were PLS and LTR. However, I was seeing gaps across the basket and they have all been routed of late. Thus I decided to take a basket approach if gap was significant enough. This was the case in AKE and LYC based on my limits. I decided to be more cautious with IGO given incoming news re Cosmos asset and stock didnt gap down. I also wanted quality and liquidity so I left CXO. I inputted my variables into my spreadsheet (see below) and auto entered algo orders from this into market with correct limits.

• Open: PLS matched on 3.2m shares or $10m. LTR matched on 279k or $339k. AKE matched on 340k shares or $2.7m. 10% fills in PLS = 300k; AKE = 34k so very achievable.

• Entry: I defaulted to Vwap first 15mins as per my rules with my limit. I really wasnt expecting a significant gap given overnight comps and our moves yesterday. However, PLS huge rogue seller and AKE -2% versus overnight fair value. Thus I bid more PLS in the match dma and vwap working in the background. Good process pre-loading algo orders BUT I missed MIN as gap was only -1.15% and I wanted more.

• Sizing: Basket approach $250k per name was the goal as per my template. On review, IF this was a A opportunity or better, $250k in PLS is really weak sauce given size of gap and liquidity of the name. I got to 150k shares across all accounts which is excellent so adapted well on the fly. AKE I was short of my goal as it wasnt a true setup given not weak enough previous day.

• SEE IT MOMENT: PLS gapping down way more then expected. The gap IS the edge. It was bid over 650k on the match so huge protection. This one went straight from the start and led the sector. Best trades go straight from the start. Clear turn higher across the sector by 10.10am with opening ranges breaking to the upside. All volume being done into the offer and meaningful volume lifts.

• Exit: 11am idealised for Trade 1. Hold to close for Trade 2 once clear capitulation is in which was clear to me by 10.30am

• MAE: 0. Literally nothing went offside

• Total capturable move: All day

-What did I do:

• Entered orders from spreadsheet and more DMA on market. See prints below

-Better next time:

• Sizing: On review, IF PLS was a true A opportunity on that gap, I think I could have got to $750k-$1m. Why not? That is 250k-300k shares. I dont see any reason why I couldnt have vwapped in 100k, dma 100k on open given gap, add rest on the turn. I also didnt commit to my AKE size and fell short. I think once the clear turn was in for whole sector, you had to pig it and lift offers in the majors.

• Management of trade: clearly I was out scaling too soon into first rip and extension. My rules are to hold until that 11am window at a minimum. Reality is trade is working from the start and shortbase is high and I have the perfect entry. This was a real turn and Daily climax = be hands off. WAIT FOR THE TURN. WAIT FOR 11am. If I want to take some profits to ease the mind, think about that 1/8th rule. I was guilty of see money, take money given recent trading.

• Tech solutions: none needed as spreadsheet all loaded. Better variables to guage extensions for big caps

-Charts:

PLS

Clearly scaling out too quickly- Its only 10.15am!!! I was actually selling small bits hoping stock would go down so that my vwap order would get more. Not to be. When i recognised the strength i really tried to be more backfoot.

Almost no meaningful pull ins early. No clear add spots. This is confirmation it is sold out.

Daily

LTR

AKE

LYC

MIN

Gap not big enough so I missed and I waited for my breakout patterns