Barriers to Success
Stockscores.com Perspectives for the week ending April 6, 2008
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In this week's issue:
Consider this situation. A stock gaps down on the open and in the first 15 minutes of the trading day moves below the price where it opened. The sellers are obviously motivated and in control of the stock making it a good candidate for a short sell. Where do you enter the trade?
To answer this question, we must consider where the stock is going but also how well we can manage risk. As a trader, it is not enough to see an indication of the likely future direction that the stock will take. We also have to consider the ideal way to balance the risk of the trade with the opportunity to make money.
It is important to recognize that, in the stock market, anything can happen. On some trades we will make money and on others we will lose, but it is impossible to know with certainty what the outcome will be. The job of the trader is to maximize value over a large number of trades, accepting the fact that there will be losses along the way. Losing is part of making money.
So, when I am considering a trade, I am more concerned with the risk and reward potential of the trade rather than where the stock is likely to go. If I think the market is going to go lower, I need to decide whether it can go down enough to compensate me for the risk of taking the trade.
As a result, I look at trades in terms of barriers. First, where is the barrier that will tell me that I am wrong? Looking at a chart, I need to be able to see a well defined price floor or ceiling that defines the point where either the buyers or sellers took control of the market. That way I can establish a threshold to exit the trade at a loss. On a short, I will look for the stock to close above resistance and on a buy I will look for the stock to close below support. If that happens, I have to exit the trade at a loss.
What is important is that I use the chart and the barriers established by market participants to make that call. It makes little sense to base stop loss points on an arbitrary percentage or dollar value movement in the stock.
The next barrier I consider is that which may limit reward. How far can the stock go in to the profit zone before the buyers or sellers will be motivated to act against me? These barriers tend to be established at past points of consolidation, those price levels where a lot of people traded the stock. If a stock traded sideways for some time at a certain price level then we should expect that buyers and sellers will be motivated to act at that price level again.
With these barriers in mind, we can then calculate whether the trade makes sense. I want trades where the reward is at least twice the amount of risk that I must take.
My focus is not just on the direction I expect the stock to take, but whether the barriers established by the market put the trade in my favor. What is my risk?
Think of it this way. If you are standing on the side of the road considering whether it is safe to cross, you look at a few different factors. How many cars are on the road, how fast are they traveling, are the drivers likely to stop for you, is it dark or light and how fast can you move across the street. There are always risks, but if the risks outweigh the benefit of getting across, you simply will not make an attempt.
I was watching a TV show on Friday where the hosts pick stocks. Of 9 of their picks, I agreed with them on 8 in terms of the direction they expected the stocks to move. However, I would not have taken any of the trades they suggested because they all had too much risk for the reward potential.
Think like a trader and put more dimensions in to your analysis, it will improve your overall profitability.
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The major market indexes have been trying to make a comeback over the past few weeks but I expect that this bounce is going to fizzle out soon. The indexes are coming up to resistance where I expect the sellers will find some motivation to act again, sending stocks lower in the weeks to come. With that in mind, I think that short selling position trading strategies are appropriate, so I again ran the Long Term Breakdowns Market Scan this week and found a couple of stocks that should be lower in the weeks and months ahead.Back To Top
1. JNPR
a new closing low for the last year on JNPR, the stock is in seller control and the break through support should lead to a move lower with a likely short term target of $20. Resistance at $26.
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2. CATY
the momentum is downward on CATY, I think that the close at new lows on Friday after about a month of sideways trading indicates the stock is likely to continue its downward trend. Consider a short position so long as the stock does not rise back above resistance at $24.50.
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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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