The Volcano (Part 2)
In the first part (Click here if you missed it) I laid the foundation of what a Volcano trade is. Let's quickly summarise it:
On a day the number of people trading a stock goes up all of a sudden because of some news or other positive event.
Most of the time this rise is due to traders over-reacting and because of this the stock falls down the next day.
In the Volcano strategy, we will take advantage of the fact that the stock is likely to fall on the next day
Now let's get to how to actually spot and take the trade.
One thing to remember is that the Volcano is a short selling strategy.
We sell at the open of the day and buy at the close. (Read my post on Short Selling if you aren't familiar with the concept by clicking here.)
Step 1: Spot the indicator
The indicator of this trade is simple:
On a particular day if we have a surge in traded volume of more than 500% compared to previous day and;
On the same day, stock price goes up.
Step 2: Take the trade
Once we get the indicator, on the next day, we sell the stock at the opening of trading. And set a stop loss at 2.5% above entry price
At 3.15 we buy the stock and close our trade.
Let's take an example from 3 days back.
This below is the daily chart of Cholamandalam Investment and Fin Co Ltd (CholaFin)
Look at the part circled in red. It represent number of shares traded.
If you notice on the 23rd of April the number of shares traded went up by a large number. (Volume rose from 2108 on 20th Apr to 58,132 shares on 23rd Apr)
Also, the stock price went up on that day.
Thus we have our indicator.
On the next day, the stock actually fell.
So on the next day 24th of April, we sold the stock at opening i.e. Rs. 1707
By the end of the day the stock had fallen down to 1650. We bought the stock at this price.
Thus, we ended up making (1707-1650) Rs. 57 per share.
We thus took advantage of investors panic and made a decent return of about 3% in a day!
Thank you for reading today's post. In fact, if you read this post today (27th April) keep an eye on the Axis Bank stock on Monday. It gave a volcano indicator today.