After The Trade Entry
Stockscores.com Perspectives for the week ending August 13, 2005
In this week's issue:
I have met a lot of investors and traders who half jokingly state that they would be profitable in the stock market if they just did the exact opposite of what they have been doing. When a stock looks good to buy, short it. When a stock looks like a good short, buy it. For the trader who consistently loses money in the market, this logic makes pretty good sense. However, simply reversing the entry position will probably not allow them to fare any better.
Trading is not only about how to enter a position; it is also about what to do once you are in.
Have you ever had a position go from a profit to a loss? If you look at your recent trades, do you find that one big loss outweighs many of your gains? Have you ever sold a stock at a loss only to watch it go up after? Have you ever passed on a trade that then turned out to be profitable?
If you answered yes to any of these questions then you are a normal person being welcomed in to the frustrating world of stock trading.
Each of these problems relate to risk and emotional management. Most books about the stock market don't talk a whole lot about this. Instead, they discuss how to pick the next winning stock. Most people who write books about the stock market don't make money in the stock market.
Allowing a good trade to turn in to a loser relates mostly to greed. You may be hoping to see a stock provide a certain amount of profit and when it starts to pull back you ignore the weakness and hang in. Rather than listen to the market, you are listening to your heart. Rather than sell, you hope that it will turn around and provide the big profit. The winner turns in to a loser.
Having a big loser on your books is caused by an inability to limit losses. It is the fear of losing that causes you to hold on to your loser and hope for a turnaround. Rather than listen to the market's message of weakness you hang on to a loser until you can not endure the pain any more. One big loser can hurt 10 winners and destroy your confidence.
Risk management is essential to consistently beating the stock market, and a big part of risk management is selling stocks when they hit your stop loss point. Getting stopped out only to watch the stock turn around and make good gains is very frustrating and causes many people to want to not use stops, claiming that the market makers are out to get them and rip out stops. If this is happening to you, the problem is either that you are setting your stops at the wrong price or you are trading marginal opportunities.
Never set your stops at even dollar amounts, at Fibonnaci levels, at technical support. That is where everyone sets their stops. That is where market makers take stocks to rip out stops. Be smarter than the crowd.
The more important issue is the quality of trades that you are taking. Great trade set ups don't usually flirt with stop loss points but good trades often do. If you have a higher standard for the trades you are entering then your success rate will improve. So will your mental health.
Passing on good trades that turn in to money makes is a direct result of the other problems. When you lose money you lose confidence. Without confidence, it is hard to take trades that are destined to make money.
Making money in the stock market is simple. I teach courses that most people can get through and understand in a couple of weeks. However, trading the stock market is not easy. Our emotions get in the way of following the rules. They taint our perceptions. They lead us to make bad decisions. To learn how to trade the stock market takes time and hard work. Simple.Back To Top
The most important factor affecting stock price is information. As information about the earnings potential of a company is made public, prices move to reflect the new knowledge. Often, stocks move in advance of the public release of information because there are market participants who have access to the information early. In other words, the process of information dissemination is gradual and not always fair.
Fortunately, this process often shows up in market activity. If significant new information is available, those with access to that information at an early stage may buy or sell in the market. In doing so, they can cause abnormal market activity.
For example, if an individual learns that Company A is likely to announce an alliance with Company B that will have significant impact on Company A's bottom line, that individual may decide to purchase shares in Company A. If there are enough people with enough buying power doing this, they can cause the price of Company A to move significantly, and trade an abnormal amount of volume.
Mathematically, we can define what a normal price move for a stock is based on its past trading history. A stock like Microsoft may move up or down 3% on average in a day. A smaller, more speculative stock may have a greater range of price movement. Based on their specific trading history, it is possible to extrapolate an expected range of price movement for the next trading session. If that stock moves outside of that range, it is deemed to have made an abnormal price change.
We can apply the same reasoning to the quantity of stock traded on a particular day as well. If a stock trades far beyond the average number of shares that it has traded historically then, statistically, it has traded an abnormal number of shares. Identifying stocks that make statistically significant abnormal price movements while trading an abnormal quantity of shares provides clues that the stock is trading on significant new information. That information may have been made public, market participants may be making an educated guess on future information, or privileged market participants are trading on private information. In certain situations, stocks that behave abnormally are often telegraphing future price trends.
Identifying stocks that have made statistically significant abnormal price gains is an excellent way to find stocks that may continue into up trends. However, using only this filter is insufficient as you will simply find too many candidates and a success rate for finding winners that is too low.
Recognizing that price volatility defines uncertainty, we also want to focus on stocks that have recently been in a period of low volatility, relative to the past trading history of the stock. Market participants are confident about the value of a company that shows little volatility. In other words, the market is confident about the price it has given to all available information. Therefore, if a stock breaks from this period of low volatility with an abnormal gain, we hypothesize that the move was motivated by new information. This new information will take the stock higher as more people learn about it. If the stock makes this abnormal break out of a period of low volatility with strong volume support, we have even more evidence that there is new information causing some investors to get excited.
The concept of resistance is very important to this strategy. When looking at a stock chart, it is relatively easy to see that there are price ceilings that seem to prevent a stock from moving upward. In our previous example, that ceiling was at about $12. This line of resistance is really just a boundary above which the market is unwilling to pay. Based on all the information that the market has about a company, the market is unwilling to pay more than the resistance price.
Therefore, if a stock breaks above resistance, it may imply that there is new information that makes the company worth more, and therefore, the market is prepared to pay more. Therefore, the logic of this strategy is as follows. Identify stocks that are behaving abnormally to the upside and trading abnormal amounts of volume because that is an indication that there is something positive happening. If the stock is moving from a period of low volatility, we can assume that the market was confident about the valuation it has given the stock. Further evidence of new information is found if the stock breaks from this period of low volatility and above a line of resistance to prices beyond which the market was previously unwilling to pay.Back To Top
1. V.CVQ
V.CVQ is breaking from a cup and handle pattern through resistance at $2.75. Volume on Friday was the strongest seen in months and the stock closed near its high of the day. The Stockscores indicators have recently gone bullish indicating that this stocks sideways trading pattern may be evolving in to an up trend. Support at $2.65.
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2. NVDA
NVDA was in a strong up trend that ran out of fuel in February, leading the stock to go in to an ascending triangle pattern since. On Friday the stock broke out from that pattern and now looks like it wants to continue the long term up trend. No resistance and support at $27.50.
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3. AAPL
A nice cup and handle pattern breakout on AAPL, the stock is at new highs and looking to go higher. The Sentiment Stockscore recently crossed above 60 indicating investor optimism returning to the stock. Support at $42.25.
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References
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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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