When To Sell
Stockscores.com Perspectives for the week ending February 18, 2006
In this week's issue:
When do you sell? The simple answer to this important question is when the stock closes below support. However, there are a number of issues to consider in defining support and getting a sell signal.
Philosophically, you want to sell the stock when the market no longer believes that there are fundamental reasons to justify paying higher prices. Investors are not always rational in their assessment of fundamentals so sell signals are often based on emotional reversals.
Stocks will tend to make some abnormal price moves when there are new motivations to pay higher prices. Therefore, we put support at the bottom of abnormal price moves to the upside. If the stock closes below this support price, we sell.
We can define abnormal price moves in two ways. The longer term method is to use patterns. If you look at a chart, patterns in an up trend are like steps upward. Look at the chart of T.CLL for example. Notice how it makes a push higher for about a month, then goes sideways for a while before breaking out and going in to another step up? Each step has a pattern of price consolidation and the bottom of the consolidation is support.
The shorter term method is to use individual candles on the chart. A candle that is taller than the majority around it is termed a Message Candle and we put support at the bottom of the last Message Candle. If a subsequent candle closes below the last Message Candle bottom, a sell signal is generated.
This is a simplified explanation of selling that is elaborated on in the StockSchool Pro course material. With a basic understanding of the concept of when to sell, I now elaborate on how you apply it.
The sell signal should match the time frame of the buy signal. For example, if you identify a stock that is breaking to all time highs from a long term ascending triangle pattern, then you expect a long term up trend. Therefore, you should intend to apply a long term exit strategy of patterns or perhaps weekly Message Candles.
If you are looking at a swing trade set up on a break from a flag pattern then you will apply a shorter term sell strategy because the expectation for the trend is much shorter. In this case, you will apply a Message Candle strategy.
The sell strategy is complicated somewhat when you get into a fast moving stock. If the uptrend becomes very steep and the market is filled with emotion, I recommend shortening your sell strategy. If you were looking for a Message Candle breakdown on the daily chart and the stock starts to move in a parabolic up trend, switch to a Message Candle breakdown exit signal on the 60 minute chart. Basically, the sharper the up trend, the shorter the time frame for the sell signal.
This summarizes the basics of the selling strategy when you are in a profit taking position, but not all trades work. It is also important to limit losses when you are wrong.
To do this, plan your stop loss point when you are entering the trade. However, in most cases using a stop loss order is not appropriate because the market often comes down through support intra-day but then rallies back before the close to remain above the stop loss point. Therefore, it is best to exit the stock at a loss if it closes below the stop loss point, not simply moves below it.
Knowing when to sell a stock you own is a challenge greater than knowing when to buy. The Stockscores Approach uses this method which becomes relatively simple with practice. What is most important is to keep emotion out of the exit strategy. Fear and greed have no place in determining your exit points.
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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.
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1. T.KMP
T.KMP breaks through resistance at $3 Friday with strong volume supporting the breakout. With support at $2.75 and no resistance to deal with, it presents a good risk reward trade off.
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2. ADAM
ADAM breaks from an ascending triangle pattern, taking it through $10 on good volume. This break makes the second step up in the up trend, giving the stock good upward momentum. Support at $9.
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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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