Review of Your Performance
Stockscores.com Perspectives for the week ending December 26, 2005
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In this week's issue:
The end of the year is when you should do some self analysis. For investors, New Year's is a good time to make resolutions that go beyond weight loss, quitting smoking or being a nicer person. It is time to look at our year of stock trades and identify areas that need improvement. To help us break our bad investing habits for more than a few weeks, it is also smart to write down our trading plan and set goals to measure our performance against.
Knowing what we need to do better first requires us to look at what we have done. From now until Jan 1, I think every trader should go through their trades and calculate the following metrics to determine areas in need of fine tuning.
Percent Gain
Figure out how much money you made or lost this year. The overall market was essentially flat but the Canadian markets were up about 23%. A Canadian market investor may think they did well by making 18% this year, but if that is what you did then you failed to beat the market. When considering the percent gain in your portfolio, you need to compare with the general market. If you failed to beat the market, then you would be better off simply buying a market index and not working so hard.
Win/Loss Percentage
How often you are right versus how often you are wrong is not that important by itself, it needs to be combined with the next measure of performance. I have seen investors who are only right 30% of the time make good money while an investor who is right 70% do poorly. Calculate this number to compare in consideration of the next.
Risk/Reward
What is the average gain on your winners and how does that compare with the average loss on your losers. The lower your Win/Loss percentage, the higher your Risk/Reward ratio needs to be. The Reward component is the average of what you make on your trades when you are right while the Risk is what you lose when you are wrong. If you are right 70% of the time, then you should average at least 1.5 times the reward for the risk you take. If you are right 30% of the time, then the average reward will need to be much higher than the average risk.
Taking a Look at the Numbers
You first look at your Percent Gain to tell you whether you can pat yourself on the back or not. But, even if you beat the market this year you should not congratulate yourself too much. Maybe you got lucky, maybe you are not as smart as you think. Regardless of your performance, everyone can find a way to do better.
The key is to look at the other measurements together. A lower Win/Loss percentage is ok if your Risk/Reward ratio is high, but look inside the numbers by printing out the charts of all your trades. On those charts, mark where you bought and where you sold and sort the charts by gain, putting the biggest losers on the top of the pile.
Look at the biggest losers and ask yourself whether you broke any of your trading rules when you bought and sold those stocks. The big losses may come from not exiting the trade when the market told you that you were wrong, and letting a small loser turn in to a big loser. You may find that you should have never entered the trade in the first place, that you did so for emotional reasons. Maybe you listened to the story too much and fell in love with the stock, ignoring the market's opinion of it in favor of your own. Maybe you bought too much of one stock, letting your risk exposure get way too high for the size of your portfolio.
Now take your five biggest losers and figure out how many of your average winners you needed to have to pay for them. Hopefully doing this will drive home the point that you have to control the size of your losers.
Examine the charts of your losers. Look at what the stocks did after you exited the trade. Did many of them continue to go higher? Did you repeatedly sell too early? It is common to want to lock in the feeling of making money, to avoid the fear of having a winner turn in to a loser. As a result, we tend to sell our winners too early..
By this point you should have some idea of areas that need improvement. If you are like most people, you let some of your losers run away from you. You may not have been fussy enough on the trades that you entered. You may have sold your winners too early and not achieved the full potential of being right on the trade.
Now it is time to make a plan. With a list of mistakes written down on paper, ask yourself why you made those mistakes. Don't blame your big losses on anyone or anything else, you are responsible for everything that happens to you in the market. Did fear and greed play a role in your investment decisions in 2005?
With an improved awareness of your weaknesses, make the plan that will help you overcome the problem areas. Write the plan down and set rules for your own investing. Do something to get leverage on yourself so you will not want to break the rules.
Investing in the stock market is simple, but not easy. Our emotional minds are what make success difficult to obtain. If you can learn how to not be a normal human being you start to be a good investor. By January 1, you should be ready to trade like a winner for 2006.
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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.
In the past week, I featured three TSX Venture stocks that met the criteria of this strategy in the daily Perspectives newsletter. Each still look pretty good, here are my comments on each of them:
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1. V.HAO
I featured this stock three days ago and it has already gone up quite a bit since but I think it can still go higher, although I would prefer to see a pull back and consider it on weakness (provided the stock does not pull back through support at $0.22.
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2. V.KTV
V.KTV broke out of its trading range four days ago but has not gone anywhere yet, so I think it is still worth looking in to provided it does not go through support at $0.90.
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3. V.TVC
V.TVC made a breakout from an ascending triangle pattern four days ago and looks like it wants to go continue its longer term up trend provided it can hold support at $0.65.
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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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