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Discussion of RL Trade Setup

Last week the model portfolio took a short position in RL.  This is a setup based on the Elliott wave ending diagonal pattern.  The ending diagonal pattern is one or the complex and specific patterns that exist.  In other words many more rules need to be satisfied to create a possible ending diagonal than any other pattern in a wave counter’s bag of tricks.

For those familiar with the Elliott wave framework, you will recognize the wave structure shown on the daily chart.   For those who are not, simply know that an ending diagonal has five waves and in our chart they are shown with the numbers enclosed in circles.  There are a few important things to know about this setup:

  1. The move meets all the rules of an ending diagonal.
  2. The sloppy move fore most of the pattern is difficult to count in another way.
  3. In an ending diagonal, wave 5 must be shorter than wave 3.  In this pattern, that rule would be violated at 178.65.  The current high is at 178.47.

There are some quirky elements to the pattern as well.  Even without those quirks, we could never be 100% certain in a pattern, but these give us some slight pause.  However, any trade above 178.65 identifies that the pattern is busted, so we know when we need to exit and it isn’t too far away.  That lets us play for the recent gap up as an exhaustion move and we know what would need to be seen to treat it as a breakaway gap instead.

We don’t want to completely dismiss the pattern concerns either.  After all, the fact that we can contain risk to our stop just sets us up for a death by a thousand cuts.  If we repeatedly make trades with contained losses then we still lose in the end.  So we will factor a few other things into our trade which we can see on the 15 minute chart.  After an initial pullback from new highs, RL did not immediately turn back up again.  Attempts at higher prices seem to come as opening gaps which are then filled.   This suggests that even if RL goes for a new high, it will try to build a base here first.

Based on these observations, we decided to sell a call spread as a bearish play on RL. This approach makes money as prices fall and as time goes by.   Therefore the greatest risk is if RL rises to above 178.65 quickly.   However, even if the pattern is wrong about direction, if it spends time building a base first, then decrease in the time value of the calls we sold may offset some or all of the losses from the directional movement.

Overall, this is a small position.  However, it is something that the we can do while waiting for larger opportunities to establish themselves.

This is a fictitious model portfolio managed to demonstrate trading techniques which may be used to trade a speculative account. The description of this hypothetical transaction is for education purposes only. Nothing related to the portfolio should be interpreted as a recommendation to buy or sell any security and the general techniques employed may not be suitable for every individual. Past performance of these techniques or this portfolio may not be representative of future results and results shown may vary from actual, live trading results subject to commissions and live market conditions including liquidity.

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