More to Trading Than What to Buy
Stockscores.com Perspectives for the week ending February 12, 2006
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In this week's issue:
What makes a good stock market trader? A person beginning their study of the stock market will put their focus on identifying opportunities, how to find the next winning trade. There are numerous stock trading programs that focus on knowing when to buy. Some of these software programs have simplified the entry decision with green lights, others produce buy signals with seemingly very sophisticated analysis. Most all of these magical systems for trading the stock market miss the point.
Contrary to the beliefs of the neophyte investor, trading the stock market is not about knowing what to buy, or when to buy it.
The decision to enter a trade is only one part of the formula for successful stock market trading, and its mastery will not ensure success. While we have all heard of the guy who bought some hot stock early in its up trend and held on till it was worth a fortune, the reality is that most of these stories have an epilogue. For most who lack the complete suite of trading skills, stock market profits are nothing but short term loans.
Long term success in the stock market also requires the ability to manage risk effectively. How much of a stock do you buy once you have identified it as an opportunity? More importantly, when do you decide that the market has proven you wrong and it is time to take a loss? For many traders, the quantity of stock purchased is dictated by the amount of capital at their disposal, and the exit point is driven by emotion and not analysis. Many traders turn in to long term investors because they would rather ride out a loser instead of take a loss.
Suppose that the trader has evolved in to a very good stock picker, and has a firm grasp on proper risk management techniques. Are they now ready to take the market bull by the horns? Unfortunately, they are only half way there, because the other half of the trade is something called selling. I find that this is where most aspiring traders truly lack skill.
The stock market is a probability game, which means that each of us can not expect to be right all of the time. Our success is dictated by how we do over a large number of trades, and should never be judged one trade at a time. We must accept the idea that our winners have to outweigh our losers, which makes the ability to know when to sell so important.
This is a double edged sword, for we must learn to minimize losses by selling stocks when the market proves us wrong, but also let profits run higher when we have made a good decision. It may feel good to sell a stock that makes you a thousand dollars in a very short time, but selling a thousand dollar winner is foolish if the stock is destined to gain another four thousand dollars. Limit downside, and let profits run.
The ability to identify good opportunities is important. Knowing how to manage risk effectively is essential. Proficiency at selling stocks at the right time is also mandatory for success. However, above all else, it is important to have the discipline to consistently apply good methods. Emotion is the enemy of every trader, and all good traders must learn to fend off emotion at its earliest appearance.
This is what turns the simple act of trading in to a difficult endeavor. When we put cash on the line, we get nervous because most of us have an emotional relationship with money.
Good traders are cool when watching a profit grow, and unshaken when the inevitable loss presents itself. They look at the big picture of trading, and judge their success on a weekly or monthly basis, rather than by their last trade. There is an art to trading the stock market, and that successful trader know how combine many different skills to paint a very pretty picture of profit.
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Companies that announce major news after the close of trading will often gap up in price the following day. An upward price gap occurs when the low of the current trading day is higher than the previous day's high. This abnormal price activity is useful because it indicates that the stock is trading more on its own story and less on the general movements of the market.
The Gap Ups strategy seeks stocks that are gapping upward on abnormal volume from low price volatility. Adding in these extra criteria improves the probability of picking a stock that is likely to go in to an up trend in the future. By focusing on stocks with low price volatility before the gap, we focus on stocks that were truly surprised by whatever motivated the price gap. Since the market's psychology is shaped by the past performance of the stock, price gaps tend to influence the market's mood favorably, and create optimism. This optimism can lead to a further price appreciation.
However, stocks that gap up often have to take a rest before they try to go in to an up trend. The sudden move to the upside is met with selling pressure as some investors happily sell at a profit, without regard for where the stock may be going in the future. When faced with fast money, many investors take their profit and run.
Therefore, it is often better to wait for entry in to a stock that gaps up in price. After the gap up, patience for a subsequent close above the gap day high can improve the probability of success again. Of course, having this patience can also mean paying a higher price, or being left without a position in a strong stock.
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1. HYC
HYC is breaking through resistance from an ascending triangle pattern and has good volume supporting the breakout. Support is at $6.70, consider the breakout false if that price floor is violated.
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2. MZ
MZ makes a little break on on volume and looks like it wants to move up in to the $1.90 resistance level. Support is at $1.35 so the risk reward trade off is a bit tight but swing traders may want to consider the stock.
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3. V.CUU
V.cuu does not normally have a lot of liquidity but it traded pretty actively on Friday and made a strong break out of very calm market conditions. It looks like something has the market excited making this stock worth considering so long as support at $0.29 can hold up.
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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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