It’s important to have a set of rules that you trade by. That doesn’t mean that you follow them each and every time, because no stock and no trade is the same. As a result, some flexibility is required, but overall, you should have good set of rules when trading small cap stocks (or any type of stock for that matter). If you are new to trading, it is better that you adhere to rules every time no matter what. 

So what I’ve done with this post, is provide you with the trading rules that I try to abide by each and every day. While they aren’t written in stone, they are my guide in helping me to make wise decisions with my trades, whether it be the entry, the management of the trade, or the exit. I trust these rules, so I’m not constantly looking for reasons to justify not adhering to them. 

1) I trade stocks on the breakout

  • Breakout to recent/new highs
  • Breakout of resistance
  • Breakout of a bull flag/wedge
  • Breakout that confirmed a double bottom, cup-and-handle, inverse head and shoulders, or other related price pattern. 

2) Avoid jumping in plays when the market moving down unless volume is remarkably strong in the trade setup and bucking the overall market trend. 

3) If at all possible avoid the first 5-10 minutes of the trading session for trading small-cap breakout plays. 

  • High amount of head fakes during this time. 
  • Large spread in bid-ask – risk getting a very, very bad fill using a stop order. 
  • Exception would be unless the trade is a high-probability trade, (i.e. very strong setup with huge volume pouring in (and in previous days) and favorable price action of late)

4) Guidelines for holding a stock overnight

  • All stocks are day-trades until there is a legitimate reason to hold a particular trade overnight – its got to earn that privilege. 
  • Positive Volume Buzz, preferably over 100%
  • Meets the volume requirements and holding the breakout level favorably. 
  • Volume surge at end of day with good price action with it. 
  • Bucking market weakness. 

5) Guidelines for getting out at the close

  • Price action on the day, is coming off of a huge gap-up on the morning open, and failing to hold the day’s lows.
  • Failed to maintain the breakout level. 
  • Volume deteriorating
  • Large upper shadow on daily candle.
  • Earnings after bell/tomorrow morning. 
  • Sold off noticeably into the close. 
  • Already seen extensive rally and trading outside the upper bollinger band with a bad track record for doing so. 

6) Signs that point to getting out right now

  • Stock should do what you expect it to do fairly soon into the trade. When it doesn’t get out. 
  • Breaking below key intraday support level that has been previously established. 
  • Breaks the day’s lows. 

7) When to book gains intraday

  • 2 very strong/convincing candles/bars on the 30 minute chart (i.e. 9:30am ET and 10am periods). Usually a good indication the stock has hit the highs of the day especially when the market is weak (true usually 9 out of 10 times).
  • Very,  very weak market open and very strong open in the stock. Usually short-lived. Don’t wait to see if the market bounces, just take the gains. 
  • Very extreme and sudden move higher on the 1min chart. Particularly if rumor driven. It’s unsustainable and a gift from the market. Will usually get shorted by the bears 9 out of 10 times). 
  • Can’t break through well defined resistance on the daily chart. 

8) Placing Stops – Be Aggressive – worse case you get stopped out earlier then you’d like and you have to play the breakout again. 

  • Don’t sweat being stopped out too soon. It happens and it’s part of trading. The fear of this leads to greater losses long-term. 
  • Get to breakeven with the stop-loss as quick as possible. 
  • Look for breaks of intraday support for stop-losses. 
  • Huge move higher try using a 2-3% trailing stop if no ideal stop area exists. Should be enough to see what kind of momentum the stock has left in it. 
  • Place initial stop a shade below the breakout level (one in which your comfortable with the possibility of a loss should it hit) if there are no other ideal stop areas nearby. True breakout plays hardly ever dip back below the initial breakout level. 

Once again these are the rules that I use and I would recommend that if you are going to use these, that you tailor them to your style of trading and personality. For more help in your trading, feel free to check out some other educational and trading related articles in our Education Center.