Looking at Stocks Going to the Mattresses

From urbandictionary.com:

going to the mattresses — to prepare for a protracted fight

From the movie “The Godfather”:

CLEMENZA: That Sonny’s runnin’ wild. He’s thinkin’a going to the mattresses already. We gotta find a spot over on the West Side

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Thursday’s trading session finally gave us a bloody close on the lows, with some noticeable fear coming back into the market. While the bears are firmly in control, riding the short side now carries the risk of an increasingly probable violent snapback rally, if only for a day or two, as plenty of traders prematurely positioned for a bounce began throwing in the towel towards the closing bell. As such, I covered my remaining short positions inside 12631 and moved to a 100% cash position.

Unless we are on the cusp of a market crash, the presumption is that we are now rapidly approaching a short-term low. The key in trying to play any type of counter-trend move is always being extraordinarily organized and disciplined in your approach, since you are essentially playing a game of chicken with the market. You simply must define your expected timeframe, capital at risk, and exit strategy before you come close to executing the buy order. Of course, there is absolutely nothing wrong with sitting in cash and waiting for the market to firm up technically to the point where we can look for a sustained move higher like we had in the first quarter of this year.

Nevertheless, I know traders want to trade.

With that in mind, a useful way of looking at this type of situation in the market is to assess those stocks that are offering an edge. WYNN has sold off for over two weeks now, moving lower in a literal straight line. In and of itself, that does not necessarily offer an edge for a trader looking to play the long side as a reversion to mean. What does appear to offer an edge for longs looking at WYNN is the fact that it has moved down in a straight line to a well-defined price area with memory. In other words, as you can see on my chart below, $101 has meant something important to WYNN in the past. When the stock is seemingly in a tailspin with no bottom in sight, the price memory serves as an excellent reference point for traders looking for a mean reversion long with an edge.

In this case, I suggest a tight stop-loss just under $100, with an upside potential to roughly $110. You are looking for an initial bounce at these levels, but not much more. Think about it this way–WYNN is falling down from a tall building and seemingly headed for disaster on the pavement below. However, we now see on the pavement that there is a mattress directly underneath WYNN‘s fall.  The idea is to play for that initial support at the $101 street level.

Why do I say “initial”?

Because the mattress theory only works the first time you touch this key level in a virtual straight line (literal straight line in this case of WYNN). After an initial bounce, you are on your own, as the trade loses its edge and a breakdown can easily occur. I hope you see how specific of a trade setup this is. You cannot just claim that every stock cratering is automatically going to the mattresses. It does not work that way. So, while the mafioso in The Godfather prepared for a protracted fight in going to the mattresses, you are prepared for a brief but hopefully profitable skirmish.

Here are the elements:

1. A stock falling in a steep manner (not an orderly pullback!) down to a well-defined level of prior support/resistance.
2. Use the reference point to define your risk on the trade and place your stop-loss.
3. Take profits after the initial bounce (follow the shorter-term timeframes and watch for a rollover), as after that the edge in the trade is lost.

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