Rules to Trade By
Stockscores.com Perspectives for the week ending July 9, 2005
In this week's issue:
Summer has arrived, and typical for this time of year, market activity has been slow. With a range bound market, this summer could be a hard time to trade making it essential to follow a set of rules that will help keep you on the right side of the trade
Limit Losses - most investors fail to minimize their losses because they hate to feel pain. Small losses grow in to big losses that can outweigh the gains of 5 or more good trades. Trading the stock market is a probability game where you will not be right all of the time. To ensure long term profitability, you must keep your losses smaller than your gains.
Trade the Abnormal - the stock market is efficient which means it is difficult to consistently beat the stock market if you fail to exploit breakdowns in market efficiency. The market fails to be efficient when there are investors trading on private information or when emotional trading is dominant. The greatest clue that these things are happening are when there is statistically significant abnormal price and volume behavior, something that is tracked with Stockscores.com.
Ignore Fear - trading decisions need to be the product of good analysis. If you ever feel that your decisions are based in fear you must stop and change the behavior. The greatest failing of traders is letting fear have a role in their decision making.
Let Greed Motivate, but not Dictate - in the Academy Award Winning movie Wall Street, lead character Gordon Gecko makes a memorable speech on the merits of greed and its power to motivate the best in people. That is true, and greed can be a powerful motivator for traders to work hard and aspire to beat the market. However, when greed affects your trading decisions, you are probably making a mistake. You should never hold a stock because you want to make a certain amount of money, or sell a stock before its time because you want to lock in a profit. Greed is an emotion that has no place in your decision making.
Lead the Crowd - when an investment idea has hit main street, it is too late. When the masses are talking about the great performance of an investment, it is probably time to sell. Bubbles burst when the mostly unlikely participant in speculation is active and encouraging others. Lead the crowd, don't follow it.
Don't Exploit the Public - information that you get about a company can either be public or private. Public information is priced in to the stock. If you make decisions based on what has happened in the past your success in the stock market will be random. No matter how good the fundamentals sound, if it is widely known by the investment community it is relatively useless.
Do What You Love - trading the stock market successfully is simple, but not easy. To do well at it, I believe you have to love the market. This will get you through the learning curve and the inevitable hard times. If you don't enjoy analyzing and trading the stock market, you should probably focus your effort on something else that you enjoy.
Don't Try to Make Sense of What Happens - the stock market, and how stocks move, is extremely complex. Trying to make sense of why a stock or market moves the way it does is a futile exercise. Simply recognize that the market is always right, even when it makes no sense. You can fight the market if you think it is wrong, but it is an expensive way to make a point.
If It Feels Too Risky, It Is - there is nothing wrong with risk so long as you are comfortable with it. If taking risk stresses you out too much, your emotions will take a role in your decision making and that will lead to mistakes. Risk only that amount of money that you are comfortable losing.Back To Top
A common theme among Head and Shoulder Bottom, Ascending Triangles, Pennants and Rectangle Consolidation patterns is a break through resistance from low price volatility, usually with volume supporting the breakout. Rising price bottom formations in to the breakout point are common, but what market dynamic do these patterns really represent?
Rising bottoms are a sign of growing optimism among investors. As time passes, they demonstrate a weakening of selling force and increase power among buyers. As a stock moves up toward a resistance price point, the market is faced with the upper limit on what investors believe the company to be worth. We often see that stocks will go in to narrow trading ranges under resistance as investors come to a consensus on the value of the company. When stocks break out from this condition, they may be signaling significant new fundamental information at work in the market since resistance has been broken from strong consensus out of a period of optimism.
The Sentiment Stockscore is useful for finding optimism in the market, and the Signal Stockscore is heavily weighted on the abnormal market activity that comes with breakouts. By looking for stocks that have a Sentiment Stockscore of 60 or higher, and a Signal Stockscore of 80 or higher, we can consider charts that may have a good chart pattern set up. The Stockscores Simple Market Scan adds in some other technical filters to shorten the list of potential candidates further.
This strategy is not solely about finding stocks with good Stockscores. The most important step is visually inspecting the charts to ensure that the chart patterns are what we are looking for. A good chart pattern will have the following characteristics:
- A break through resistance
- Abnormal activity, in terms of price and volume activity
- The break through resistance should be from a period of low price volatility. Low price volatility is characterized by the price range of trading on each day (how tall the trading range is on the chart) and by the range of trading over a number of days (are the trading days side by side on the chart, or is there a price trend?)
- A show of optimism leading in to the break through resistance from low price volatility.
It is necessary to have all of these criteria, many traders forget to check whether the stock was trading with low price volatility before the breakout, or to make sure that the stock is truly breaking through resistance and will not encounter more selling pressure soon.
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1. ISPH
ISPH is breaking out from a cup and handle consolidation pattern that has gone back to the big gap down in early February. It looks like investors are getting optimistic about the stock again and we could see that big gap down get filled. Support at $8.
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References
Get the Stockscore on any of over 20,000 North American stocks.
Background on the theories used by Stockscores.
Strategies that can help you find new opportunities.
Scan the market using extensive filter criteria.
Build a portfolio of stocks and view a slide show of their charts.
See which sectors are leading the market, and their components.
Disclaimer
This is not an investment advisory, and should not be used to make
investment decisions. Information in Stockscores Perspectives is often
opinionated and should be considered for information purposes only. No
stock exchange anywhere has approved or disapproved of the information
contained herein. There is no express or implied solicitation to buy or
sell securities. The writers and editors of Perspectives may have positions
in the stocks discussed above and may trade in the stocks mentioned. Don't
consider buying or selling any stock without conducting your own due diligence.
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