How to Make Money on WallStreetBets Reddit
The 3 Step Guide for Trading Breakout Stocks from Reddit and Other Social Media Sites
There’s no denying that 2020 was the year of the millennial trader who made astronomical returns on Tesla ($TSLA +700% YoY), GameStop ($GME +600% YoY), and other highly volatile stocks. These YOLO (You Only Live Once) traders gambled their entire life savings on risky bets and coordinated their purchases with 1.8 million followers on Reddit’s r/WallStreetBets and other social media sites.
While it has been traditionally known that retail investors do not stand a chance against the Wall Street institutions, the combination of bravado and synchronized purchasing on social media has leveled the playing field for millennial traders — and Wall Street is starting to take notice.
In this article, we’ll take a step-by-step approach on using WallStreetBets to discover and profit from breakout stocks. I’ll provide a real-world example of how I purchased GameStop (NASDAQ:GME) to make an 8-15% profit on a swing trade. While this approach won’t be giving you 500% returns as seen on WallStreetBets, it will give you a risk-controlled method for making profits in the market.
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Step 1: Identifying Your Target
Screening Stocks on WallStreetBets
The first step is to identify the breakout stock you’re looking to purchase. When screening for stocks on WallStreetBets, you need to differentiate the signal from the noise as many are false positives and do not lead to profitable outcomes. To identify a true breakout candidate, look for posts with the following characteristics:
- High number of upvotes — An average post may have hundreds of upvotes before the Reddit algorithm decides to keep the rank high (whereby helping the post gain more upvotes) or drop the rank due to lack of popularity. Look for posts that have an upvote count of 1,000 or more to validate that the community is truly interested in the stock.
- Memes vs. trade posts — Many of the popular posts are of the meme variety where traders are posting for humor rather than having a real intention to buy. On the other hand, breakout stocks come from trade posts such as YOLO bets, screenshots of account profits, and risky option calls that drive FOMO and induce the community to make similar risky purchases. Look for trade posts as the better indicator of post quality.
- Quantity of posts — While trade posts are usually better than memes, a true breakout candidate will have many posts of both flavors. When scanning through the feed, quantity does matter as it keeps the stock top of mind for the community. Look for the top stock that is constantly being posted as the candidate for a breakout.
In my example, I scanned through WallStreetBets and narrowed down the potential targets to GameStop and Palantir. I ultimately decided to move forward with GameStop as it had over 30 trending posts, of which 10 had more than 8,000 upvotes. Unlike that of Palantir, interest in GameStop remained consistently elevated and took over most of the community’s conversations in the breakout period.
Short Squeeze
A struggling stock with elevated levels of short sellers has the potential for a short squeeze, or the act of short sellers re-purchasing shares to cover their losses. During a short squeeze, prices move up rapidly as the re-purchasing further moves up the price, triggering even more short squeezes to occur. This virtuous cycle is one of the keys to a breakout. To identify short squeeze candidates, look for stocks with a high short float percentage (percent of tradable shares that shorted) and a high short ratio (average number of days to clear out the shorted shares).
At the time of purchase, GameStop had a short float of 138%, indicating short interest that was unusually (for comparison, even a stock with 20–30% short float is considered high). Moreover, the short ratio of roughly 6 days meant that it would take more than a full trading week to clear out the shorted shares. Gamestop was an ideal candidate for a short squeeze.
News Catalyst
Every breakout trade starts with a news catalyst to jumpstart the move. News catalysts can come in many forms — positive earnings reports, potential partnerships, new product announcements, updated legislation, etc. to name a few. However, similar to posts on WallStreetBets, news catalysts can range in quality. Look for news that is picked up by multiple financial outlets, distributed across multiple channels (social media, web, email, etc.), and lasts for multiple days.
For GameStop, the catalyst was the arrival of new board members to shake up the online strategy for the company. The story was blasted throughout all major financial media outlets and the news story was extended for multiple days.
Step 2: Timing Your Entry
Now that you’ve identified your target stock, the next step is to time your entry. While there are tons of methods and technical indicators to do this, price action is the simple, yet effective way for finding optimum entry levels for your breakout stock.
Establish Support and Resistance
The main price action analysis is to establish support and resistance for your stock. Simply put, support and resistance are levels at which the price reverses the direction that it came from. For example, a stock falling in price will start to attract more buyers and get to a point where the price no longer falls and reverses to the upside. This price level is called support. Conversely, a stock rising in price will attract more sellers to the point at which the price no longer rises and reverses to the downside. This price level is called resistance. By understanding where support lies, you can have higher confidence that you’re purchasing the stock at the bottom of a price range.
Validation of Price Levels
To validate if a price level is a strong support or resistance, look for multiple instances of those price levels being met. Additionally, large trading volumes at price levels give you further confidence that the support or resistance will be maintained.
Resistance Becomes Support
As the price fluctuates between support and resistance, there comes a point at which a stock may break through the resistance and trade in a higher price range. When this occurs, a previous resistance can act as the new support (this phenomenon can also happen on the downside where previous support becomes resistance). If a stock breaks through a price level, look for possible entry points on the previous resistance.
Looking at the 5-minute chart for GameStop, you can see the price action during the 3 day breakout period. To start, I noticed that $34 was the first resistance point as it got tested four times on that day. On the second day, the stock gapped through the resistance in the pre-market to land at $38. At the opening, the price fell back to $34 confirming that the previous resistance had converted to the new support. Having the multiple confirmations of support and resistance, I decided to enter the trade on the third day by letting the price fade from breakout highs and purchase at the $34 support level.
Step 3: Locking in the Profits
Knowing the right time to sell is often more challenging than timing the entry. While it’s difficult to time the sale perfectly, your breakout stock will eventually run out of momentum as existing buyers look to profit and new short sellers pile on to your overvalued stock. Here are some guidelines that will help you be more consistent in locking in profits.
Sell on Resistance
Similar to using support to time your entry, you can use resistance to determine your exit. Set a limit order to sell a portion of your holdings at each resistance level. The amount you sell at each price point is determined by the risk you’re willing to take for the trade.
Limit Risk with Stop Orders
Stop orders are a great way to limit your risk while capturing the potential for further upside. Stop orders can be triggered to sell your stock only when the price falls below your stop price. By setting stop orders near support or resistance levels, you can let the stock move higher but quickly sell it if it reverses direction.
Given that I entered the trade on the third day of the breakout, I was inclined to sell on the earlier side as the run-up was potentially nearing its end. I set limit orders at $38 and $43 as they were the clear resistance levels from the days prior. I triggered a sale of 75% of my holdings at the $38 level and set a limit sell order at $43 for the remaining position. At the time of this writing, the $43 limit order has yet to be triggered and I may adjust that order accordingly. However, in case the breakout is nearing its end, I’ve set a stop order of $34 so that I can break even on the remaining shares.
The Final Result
Here’s the final result. At worst, the trade will return 8.6% but has the potential for a 15.2% return if the breakout continues. Not a YOLO trade but we’re happy to make a decent profit in a short timeframe.
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Purchase Price Per share: $34.10
Number of Shares: 300
Total Cost: $10,230
Realized Profit (Profit On Sold Shares): $888.75
Worst Case Profit (If Remainder Sold At $34): 8.6%
Best Case Profit (If Remainder Sold At $43): 15.2%
As always, I’d love to know how you’re doing on your trades. Please leave a comment or question in the Comments section below and I will respond to you as soon as possible.
Happy trading!
Content on this site is for educational purposes only.
