Managed Risk and Pull Back Plays on T.ML, T.HF, T.TRE, T.LNR and T.ABT
Stockscores.com Perspectives for the week ending July 29, 2007
In this week's issue:
Life lacks fulfillment if you are unwilling to take risks. The great rewards - love, children, knowledge, success - require you to step out of your comfort zone and expose yourself to the potential to suffer pain. Sadly, our world has become so overcome with fear that many of us fail to enjoy our day to day lives. Instead, we get stuck in routines that avoid risk in favor of a painless existence. Ironically, the unhealthy boredom that comes with this choice can be the most painful of all.
The greatest happiness comes when you manage the risks you take. Most would agree that the exhilaration of a bungee jump is lost when the bungee breaks. So, it is important to control the risks you take so that you can maximize the pleasure and minimize the pain.
This makes perfect sense when you are doing something that risks your safety and well being. Most will understand that driving a race car at high speeds is retarded if your amount of track experience is limited to playing a video game. To Michael Schumacher, pushing a Ferrari to its limits is quite sensible.
How do you approach risk taking in your investments?
Greed is a powerful emotion; it can cause us to lose sight of risk and thus, the ways to manage it. Investors can easily succumb to greed when the emotion of the market has them in its grip. For that reason, it is smart to have a written plan for managing risk. When making decisions involving financial risk, the intelligent investor goes back to the plan.
Every investment loss should be planned. Rather than think about the potential for making a profit, think about the potential for a loss and then plan how to limit that loss. Investing is not a science; you can not define exactly what will happen after you enter a stock trade. For that reason, you must plan for uncertainty.
Always ask yourself, "Where is my exit door. At what price do I dump the stock and take the loss?"
A mistake that many investors make is how they select that exit door. It is wrong to say, "I don't want to lose more than $500 on this trade and I have 1000 shares, so as soon as the stock goes down $0.50, I will sell."
This is the wrong approach because the choice of stop loss point is based on risk tolerance and not on the volatility of the stock. What if it is quite normal for the stock to move up or down $0.75 in a typical trading day? You will almost certainly get stopped out even if you are right about the future direction of the stock.
Therefore, the stop loss point must be based on the stock's volatility and its support levels. The position size must fall out of the difference between the entry price and the stop loss point.
There is still the risk that the stock gaps through the stop loss point, making it impossible to exit at the risk limit. This does not happen often, but it does happen and the potential needs to be factored in to your risk management plan.
When assessing risk, it is important to be rational in how you define it. I have a little fear of heights which makes me avoid stepping too close to the edge of balconies, cliffs etc. It is not a rational fear, I know in my brain that I am not going to be picked up off the balcony by the wind and sent hurtling toward the earth. But, I still get a nervous feeling any time I look down from some height.
When assessing stock market risk, you must be rational. Many people avoid trading in stocks because they overestimate the risk. Others put all of their money in to a very speculative stock because they underestimate it. Fear and greed can not be a factor in your assessment of risk.
Ultimately, trading smart is a matter of understanding the risks and having a plan to defend against them. Entering a trade without effective risk management is no different than jumping out of a plane without checking your parachute.
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This week saw a significant sell off and I am sure many investors are feeling like the financial world is falling apart. However, in the context of the upward trend, the recent profit taking has not been significant enough to indicate a long term trend reversal. Instead, it looks like we have simply corrected some over valuation.
That means that it is probable that the market will bounce back next week and this sets up well for the Pull Back Plays strategy. This StockSchool strategy seeks stocks that have run away from their upward trend line and looks to buy them on a pull back to the trend line. It is a swing trading strategy where we look to hold the stock for typically less than two weeks.
I ran this Stockscores Market Scan on the TSX and found quite a few good looking opportunities. Here are five stocks that I think will benefit well if we do in fact get the bounce off of the trend line that I am expecting next week.
Each stock has the same set up and is worth considering provided it does not run too much higher from Friday's closing price. If the stock pulls back and closes below the support price that I indicate below, then the entry signal was wrong.
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1. T.ML
Support at $7.85
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2. T.HF
Support at $12.15
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3. T.TRE
Support at $16.15
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4. T.LNR
Support at $19.85
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5. T.ABT
Support at $25.05
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References
Get the Stockscore on any of over 20,000 North American stocks.
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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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