How to Trade a 'Failed Bottom' Pattern

Back in October, I met with one of America's top traders... Mark D. Cook. Mark's annual returns have ranged between 30% and 1,422% since the 1980s. His interview was featured in the book Stock Market Wizards. And he shared with me one of his favorite trades...

 

It's called the "failed bottom."

 

It's a mechanical trade, which means there's no fundamental interpretation... nothing dealing with balance sheets, book value, or price-to-earnings ratios. You just make the trade when the price action tells you to.

 

The price action of the failed bottom comes in two parts: A declining asset hits a bottom and rebounds. Then, instead of shooting higher in a straight line, the asset works its way back down to the previous low... If it doesn't break through the low, it's a failed bottom.

 

By heading lower after the initial rebound, the stock fakes out traders. So trading a failed bottom is all based on fading the market... That's what the failed bottom gives you, a reference point from which to place your bets against the crowd.

 

Mark trades this pattern on a five-minute chart. So his approach is much too time-sensitive for many of us. But the same concept applies on any time scale.

 

Back in July, my Inside Strategist readers traded a failed bottom pattern on homebuilder Hovnanian. Hovnanian was down to $4.50, the same level it bounced off in January 2008. We bought it and made 42% in a week. Take a look...

 

 

 

The beauty of the failed bottom trade is its extreme profitability. The odds of making money on a failed bottom are only about 50/50. But the risk-to-reward ratio is one to five.

 

In other words, if you risk $100, you'll lose at least some of it half the time. But when you're right, you can expect to make as much as $500...

 

Good investing,

 

Brian

• Weekend Edition
  By S&A Research Saturday, January 24, 2009
  
• One of These Stocks Will Hit the 85% Buyout Jackpot
  By Dr. George Huang Friday, January 23, 2009
  
• Why Would 9-Year-Olds Sing About Erectile Dysfunction?
  By Jeff Clark Thursday, January 22, 2009
  
• Commodity Q&A: We Could See Another 80% from Here
  With Matt Badiali Wednesday, January 21, 2009
  
• Why You Should Sell into Any Rally
  By Jeff Clark Tuesday, January 20, 2009