How to trade for a potential 15% return on BP

published 20 September 2010

I've said it once and I'll say it again: it's vital to have an exit plan in place before you open a trade.

Today, I want to show you exactly what I mean by showing you a trade that aims to net a 15% profit. In fact, I suggested this trade back in June and it made a handy 20% in just 8 weeks.

How wild markets can produce great trades

In June, the market was tearing chunks out of BP. I suggested that we use the volatility in BP's shares to make a profit.

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On Friday 11 June , BP had slumped to £3.85. We were in the eye of BP's political storm. Obama and his team were piling the pressure on Tony Hayward and BP as they were looking for 'ass to kick'. Rumours abounded that BP would suspend its dividend.

With all this in the headlines, BPs volatility was sky-high. There was a great deal of hysteria in the price. Since volatility really comes down to how much the share moves up and down, it offered us an opportunity: "Buy low, sell high", goes the adage.

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I advised placing a buy limit order at £3.60. This means your stockbroker doesn't actually buy the shares for you until the price drops to that level.

And wouldn't you know it, on the Monday, the stock fell through £3.60 (hitting as low as £3.51).

BP Share price since May

Now that the trade was open, we placed a sell limit order at £4.30. Again, this means your broker doesn't sell your shares until they hit £4.30.

And 8 weeks later on 5th August, the shares went through £4.30 (hitting £4.34) and our broker sold out.

Now, let's not forget that for two weeks after we opened the trade, we suffered a nasty 'paper loss.' And it's exactly at this point that making (and sticking to) your exit strategy is so important...

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It's easy to get 'shaken out' of a trade. You fear further losses so you sell out. The problem is that this is often right at thebottom.

If you've got a strategy then stick to it! It'll save you some stress too...

Limit orders can seriously reduce stress

The beauty of limit orders is that you don't have to sit, glued to a monitor waiting for the right moment to trade. This can take away a lot of anguish and emotional stress that often leads to bad investment decisions. But I warn you, limit orders come with their problems too.

First off, you may never open the trade. Had BP not fallen below £3.60, we'd have missed our chance to 'get in' and profit from itsrise. And similarly, if you're looking to sell, the price may never hit your target. You could be sitting with a stock that you'd meant as a short term trade. As seasoned traders will tell you "What do you call a trade gone wrong?" Answer: "An investment".

Still, I reckon there's mileage in this one yet. Here's my advice.

How to trade BP today

BP's implied volatility has fallen nearly two-thirds since we opened the original trade. It's not going to be as easy to pick up a quick 20% this time round, the stock simply isn't as volatile. But then again, it shouldn't be as risky either.

Looking at the chart, I'm pretty happy with my predicted trading range of £3.60 to £4.30. But in view of the lower volatility, I'm scaling back my ambitions. I'm looking to make 15% this time round.

I'll be a buyer if BP falls to £3.70. As I write, BP is trading at £4.05 and any sort of trigger could cause a fall back into my buying range. So that I don't miss my chance, I'm placing a limit order (that will expire after 30 days) to buy at £3.70.

Now if BP falls, it'll be because some bad news is in the market. No matter how this affects my emotions, my broker will execute my order.

And if I get hit (i.e. the trade gets opened), I'll be placing a limit sell order at £4.25.

If you are interested in trading BP, here are some details you might find useful:

Ticker: LSE: BP.

Price: 406.75p

Market cap: £76, 434m

52-week low/high: 655p/302p

Bid/offer price: 406.8p/406.7p

Five year share performance: 2005 +21.85% | 2006 -8.32% | 2007 +8.37% | 2008 -14.47% | 2009 +14.07% | 2010 -34.00%

This article was first published on 17 September 2010, in the free investment email The Right side. Sign up to TheRightSide here.

Your capital is at risk when you invest in shares - you can lose some or all of your money, so never risk more than you can afford to lose. Always seek personal advice if you are unsure about the suitability of any investment. Past performance and forecasts are not reliable indicators of future results. Commissions, fees and other charges can reduce returns from investments. Profits from share dealing are a form of income and subject to taxation. Tax treatment depends on individual circumstances and may be subject to change in the future. Please note that there will be no follow up to recommendations in The Right Side.

Managing Editor: Theo Casey. The Right Side is issued by MoneyWeek Ltd. MoneyWeek Ltd is authorised and regulated by the Financial Services Authority. FSA No 509798. https://www.fsa.gov.uk/register/home.do

Bengt graduated from Reading University in 1994 and followed up with a master's degree in business economics.

He started stock market investing at the age of 13, and this eventually led to a job in the City of London in 1995. He started on a bond desk at Cantor Fitzgerald and ended up running a desk at stockbroker's Cazenove.

Bengt left the City in 2000 to start up his own import and beauty products business which he still runs today.