One of my favorite setups is shorting earnings breakdowns. Shorting momentum stocks at the open can yield huge gains in a very short period. It is even better when the stock is gapping down in reaction to bad earnings. In order to be able to capitalize on these trades, you have to know how to find the best entries. Let’s talk some more about how to enter breakdown plays, and my favorite trick to get low risk, high reward entries on this setup.
How To Enter Breakdown Plays
Entering breakdown plays is not as straightforward as you think. Breakdown plays will often be gapping down more than 10% from their prior closing price. This means that these stocks will have something called short-sale restriction turned on. This means that you can take liquidity from the bid to enter the stock. As a result it can be hard to get an entry into a breakdown play because the stock didn’t uptick at the time you were looking to enter. As a result, you will often need to add liquidity (sit on the offer and wait to get filled) in order to enter these plays.
Wait For the Stock To Spike
This is my favorite trick for shorting momentum stocks: Wait for the stock to spike instead of shorting at the breakdown area. You will probably not get filled if you try to short at the breakdown area if SSR is on, and you might get filled right at the bottom of the dip right before it spikes back up. Waiting for it pop will give you a better average for your short, and will allow you fill more size on your position.
These stocks usually don’t just go straight down. They will often retrace to their intraday moving averages before continuing their trend. They also tend to retrace to whole dollar marks after big flushes down. Both of these areas are good spots to put limit orders to get fills for these type of plays. SSR stocks can reverse quickly to the upside so you have to avoid chasing weakness.
DLTR was a recent play we took that played out perfectly. Remember, the best breakdown plays always have no nearby support levels on the daily chart. We can see the DLTR had no nearby support when it opened a few days ago:
It was also gapping down in reaction to earnings, so we knew the probability of it tanking on the day was large. You can see the stock has a quite a large intraday range, and it had a nice 3 month base it broke out of to the downside. It has in the past also had a ton of volume come into the name on days it has gapped down big, so you know there will be great liquidity. This is exactly the kind of daily chart you want to see for a breakdown short play.
DLTR did not have SSR on when it opened. It triggered after it broke the 86.70’s level on the first flush. You can see how it came back and retested the 88 level after it triggered the SSR level intraday.
That pop would’ve been a good spot to start in short in anticipation of the ORB on the 5 minute chart. If you waited for confirmation of the ORB, you could’ve gotten entry on the quick pop to the mid 86’s after the range was broken. The takeaway here is that you have to be extra patient for your entries on breakdown plays. You have to let the stock come to you, and you have to be quick and decisive. Don’t get FOMO and chase a breakdown because you think it will not bounce and go without you. They almost always retrace at some point. Don’t be a chaser!
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