How to Identify and Profit from Magnet Trade
Magnet trades are one of the high risk high reward trades in trading. It is difficult to get them right but if you can master them, you will have one of the biggest weapon in your arsenal. So, what are magnet trades?
Before we understand Magnet trade, lets understand a strong principle of the nature. Nature abhors vaccum or gaps. When nature sees gaps, almost inevitably they are filled. When you see a river flow, you don’t see a patch of land which it leaves, do you? Oh, you may argue it is not nature but Science- a property of water to spread uniformly. That’s a fair point! So lets take another example, a Forest. When a forest covers a land, do you see a patch of land discriminately devoid of trees. It doesn’t happen without any reason. You need to convince yourself that it happens all around us and you will surely see more examples of uniform spread by natural forces be it gravity etc.
So what does all of this has to do with trading? There is a strong link and it is not a hypothetical theory. It can be observed everyday in many stocks. So the basic premise of the theory is following:
- If the Price of any item (be it stock, commodity) goes far away from its current perceived value suddenly and it create a strong imbalance. (Go though this blog if you are not sure about the difference between value and price of an item)
- If the imbalancing forces are strong, it will continue to be away from value in search of its true value.
- If the imbalancing forces lose momentum or fail to see acceptance of the price at those imabalanced levels, it triggers a Magnet trade.
The gap between the perceived value and current price is the gap which will get filled quickly creating an opprtunity which is known as the Magnet trade.
In the above chart, it can be observed(Blue Circle) that the gap down was filled within 20 days of its occurrence. This did not turn out to be a very profitable trade and generally in day charts, they may not be that profitable. But I am showing it here to explain the concept and also to show you that they can occur in different timeframes.
In the above 5 minute chart, the gap opening triggered an unbalance in the value perception of the stock. This was immediately rejected by the market and it led to a very profitable Magnet trade.
Summary
It is important to observe the opening of the trade closely and keeps your guards up. The attempted imbalance can continue the momentum and in that case, it will be worthwhile to trade with the flow. Market continually attempts to explore the value of an underlying through the demand and supply dynamics. You should keep a tight stop loss. Start observing this trend and once you are sure for the movements and you can start trading this.
