Trade Thoughts
Stockscores.com Perspectives for the week ending July 17, 2009
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In this week's issue:
On July 13th, in the Stockscores Daily Newsletter, I suggested that Crude Oil was a good buy as it had pulled back to its long term upward trend line and had a good chance of bouncing. The reward potential was much greater than the risk, which added to the attractiveness of the trade. I suggested my readers watch the intraday, 15 minute chart for a break from a rising bottom. That came the following morning when Oil gapped up on the open, giving an entry at about $21.40 with a stop loss point at about $20.60.
Since then, I have received a lot of questions about this trade from our subscribers. Many questions reveal some mistakes that people make in how they trade. I would like to address a few of the problems that I have seen to hopefully help everyone make better trading decisions.
One common problem that I see is poor risk management through multiple highly correlated positions. To review, the risk of a trade is based on the difference between the entry price and the stop loss price. That difference divided in to a trader's personal risk tolerance determines the position size. So, if you bought the OIL ETF at $21.40 with a stop loss price of $20.60, you had a $0.80 per share in risk. Buying 1000 shares meant you were taking $800 of risk, plus slippage and commissions.
What many traders will do is go out and take trades that are going to move the same and, in doing so, they take on much more risk than they can tolerate. If you buy 1000 shares of OIL and then also take a position in an oil company and perhaps buy one of the leveraged ETFs like T.HOU then you have essentially tripled your risk. If the trade does not work, it will likely not work for all three and all three will be stopped out for a loss that is three times your risk tolerance.
Don't do the same trade on multiple highly correlated instruments unless you lower the risk you take on each so that the overall risk is no greater than your risk tolerance.
I am also asked many questions about when to sell. Oddly, I get this question a lot more when a trade is working and profitable than when it is not, which reveals one of the emotional problems that most traders have to deal with. We tend to want to hang on to our losers and sell our winners.
Most every up trend tends to start slowly. It is human nature to doubt positive change until there is some proof. That means people tend to jump on the band wagon late in the trend, causing the trend to get steeper as the trend develops.
It also means that you have to be patient with trades early in their trend because they will often have some pull backs that shake many traders out before the real profit making stage of the trend comes. As a result, I encourage people to only look for an exit signal once a stock has doubled its risk amount.
The trade on Oil is a swing trade which means the expected hold period is less than two weeks. After almost one week, the trade is up nicely but it has not yet doubled the risk amount. Since the risk on the trade was $0.80 a share, you should not look for the exit door unless it moves up $1.60 to $23. The high today was $22.74 so we have not yet hit that threshold.
As a swing trade, I tend to look to the intraday 15 minute chart for a signal to exit. Once the stock has doubled its risk, I wait for a break of the upward trend line. If the stock really runs away to the upside from the upward trend line, I will see on a break of very short term support defined by the lows of a tall 15 minute candle (we call these trigger candles). These concepts are taught in the StockSchool Pro course.
This trade is working well so far but there are no guarantees it will continue to work. Never count your profits until the trade has run its course and expect that some of your trades will be losers. When you are wrong, get rid of the stock and take the loss.
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Here is a swing trade to watch for. It is not time to enter this trade yet but there is a good chance we will see an entry signal in the next week.
Below I have the charts for the S&P 500 and the TSX 60 Exchange Traded Funds. As you can see, both have come up quite a lot over the past week and are now approaching resistance on their charts. That means there is a good chance they will reverse and see some profit taking in the short term.
So, the swing trade idea is to short them when they show a breakdown on the 15 minute chart. For this set up, I like to see a break of the intraday upward trend line. Second, a break down from a falling top, which has not happened yet. That may come on Monday or early next week. If it does, short the market either by buying a bear ETF like SDS or T.HSD. For the TSX, consider T.HXD or shorting T.XIU. There are also put options that can be bought on these indexes.
But, remember to wait for the entry signal, it may never come but it is likely that it will next week.
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1. SPY
Watch the intraday, 15 minute chart for a breakdown as a signal to short as the S&P 500 rallies in to resistance on the daily.
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2. T.XIU
Watch the intraday, 15 minute chart for a breakdown as a signal to short as the TSX rallies in to resistance on the daily.
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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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