Happy Monday!
I use a lot of jargon and shorthand in my webinars….
You see, my purpose with those is to get as many trade ideas out to you as I can in the allotted time I have, so I abbreviate my language.
And one I use a lot is RCT, which is the Red Candle Theory.
It’s a very simple technique that I’ve used for years to know when to enter a stock, and even more importantly, when to get out when I’m making money. That way I don’t overstay my welcome in the position and end up giving back profits.
I mentioned RCT last Wednesday during my Daily Double Down webinar. I saw two or three of these types of trade setups that day.
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So what’s the red candle theory anyway?
Let’s get to it…
What is the Red Candle Theory?
We use RNC to trade on the belief that when you see the first red candle in a morning runner, specifically the first red five-minute candle, it’s a signal that momentum is shifting.
Short sellers will hammer that first red candle, looking to capitalize on the shift and that even further reinforces that it’s time to get out of your position.
Now let’s put it into action.
Let’s use the imaginary stock XYZ as an example.
Low float, low-priced stocks are perfect for RCTs. So let’s say XYZ is a low float stock, and the company dropped some news this morning, creating great volume and volatility… These are key ingredients for a setup.
In the first 30 minutes of trading, XYZ sees 30 million shares traded. Combine that with 10 million in pre-market, and you have a classic dip and rip situation (DNR in my shorthand).
To learn more about dip and rips, read my article here.
After identifying the setup and entering the trade, you want to use a 3-to-1 risk-to-reward ratio. So, if you enter the trade at say, $3.60 per share, and you set your stop loss level at $3.30, you’re risking $0.30 per share. That means your goal should be to make $.90 per share in profit ($0.30 x 3), or a target price of $4.50.
And then comes the catch: stocks don’t always hit your exact target. Surprise!!
They might get close and then shift momentum…
That’s where the five-minute red candle candle theory comes in.
For XYZ, say it went up with multiple green candles, and you’re getting you excited…
But not so fast…here comes the first red five-minute candle. That’s your cue to exit the stock, take your profits, and pat yourself on the back, even if it didn’t hit the $4.50 target.
Look at this example of Azitra Inc. (NASDAQ: AZTR) from last Tuesday. It had the perfect setup that morning: it dropped patent news, and it was a low float stock with good volume…
AZTRA 5-Day Chart, 5-Minute Candles; SteadyTrade
That first red candle was exactly where the exit should have happened…the stock never recovered after that.
Small gains really add up.
Look at it this way: Even if you exit at say $4.10, you’re still netting a nice profit of $0.40 per share. That’s a 13% gain and for small accounts and those are meaningful numbers.
And on the AZTR trade above, if you entered after the open and exited when that first red candle hit, you could have made around 20%*! And that was within half an hour!
The key is to not turn winners into losers. Protect those gains.
Remember what I said before…once that first five minute red candle hits, the shorts are going to come in and beat it down lower. You don’t want to become a victim of that, or what I call a “bag holder.”
If you consistently make $300-$400 on predictable setups, those profits add up quickly, especially when you minimize losses. This strategy has huge potential over a week, a month, or a year.
My final thoughts.
With the RNC strategy, always have a plan based on a three-to-one risk-to-reward ratio.
When trading momentum plays like these, especially junky stocks that spike on news but don’t necessarily have healthy fundamentals, be conservative and defense-minded.
And never forget, it’s better to take profits early than to watch a winner turn into a loser because you held on too long. Don’t be a bag holder!!
And if you’re looking for more trading tools to help you spot news, trends, and identity trading setups like RNC, we have a whole arsenal of them…
From Breaking NewsChat, our trading chatroom run by a team of Wall Street veterans…
To Oracle, our algorithmic system that scans the entire stock market every morning and delivers signals to inform your trading and deliver big winners…
To XGPT, our AI tool that leverages the aspects of human psychology to try to predict price movements and how to profit from them…
And to take advantage of earnings season, we just launched our Master Calendar system which uses an algorithm to predict earnings winners.
Have a great day everyone. See you back here tomorrow.
Tim Bohen
Lead Trainer, StocksToTrade