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Sunday, August 29, 2004
Good evening friends,
Market Recap
Friday ended a very low volume up week for the market. The Dow was up +21 points Friday on the weakest volume the year. The NASDAQ was up +9 points and the S&P gained +2 points. The republican convention starts this week, and it will probably be another slow trading, low volume week. Volume should pick up after Labor Day so there is one more week of slow trading to contend with before the markets get cracking.
A Look Ahead
The charts of the three indices for today's commentary indicate they are coming up on serious resistance. I doubt the Dow will get above 10250. It should touch this level next week and reverse to the downside. A close above this level on super volume would be very positive for the market but I do not think it happens (yet). The S&P 500 has resistance at 1112, should touch there early next week, and reverse to the downside as well. The NASDAQ can get to 1895 before it sees strong resistance, so there are still 30 more points to run before it turns back. What I want to see when the market reverses is a higher low. For instance if the NASDAQ reversed, went down to about 1790, and started another technical bounce from there, that would be very positive for the market. I am still cautious, and I believe that the markets will rally into the end of the year. However, I think some downside is in store before the real rally can get started.
Short Trades
After looking at many charts this weekend, it looks like we are trapped in some losing short trades. When volume is weak, rallies are deceiving. But nevertheless, sticking to the 2% stop loss rule would have been taken us out of these losing shorts early in this weak rally. It is a frustrating time because I am stuck between a rock and a hard place. I have said for months that cash is king, but TWPD is a trading service so subscribers are not here to read that we should be in cash in every commentary. As a result, I continue to find good trades that require tight stops and smaller gains. Trading the market in the last eight months, stellar gains cannot be expected as market conditions will not allow them.
Our trading style has been to cut our losses quickly and let our winners run. That works great in bull markets. The trouble in a flat or bear market is that you cannot let your winners run because they will not run far. Instead, profits must be taken early. As a result, we have had many small gains and many 2% losses. Admittedly we have had more 2% losses than I would like, but if we choose to trade as opposed to being in cash, strict stops must be maintained. This is essential to capital preservation.
There were a couple 19% gainers in the last month, we will round to 20% to keep this simple. If 20% is made on one trade, that trade will make up for 10 losing trades that lose 2%. 9 out of 10 trades can lose and still break even. Of course losing 9 out of 10 is unacceptable, but the point is capital is preserved because your losses are cut quickly.
The two 19% winners were APOL and TINY, both short plays. Using the example above, there can be combined total of 18 loses at 2% and still break even. It is very important to cut your losses quickly and let the winners run. Of course in a bull market, profits can be enormous using this system because you will have far more winning trades then losers and the winning trades will have profits with much higher percentages.
I have not kept losses at 2% over the past couple of weeks, and I want you to know that this is a mistake. I will admit when I have made trading mistakes, and not sticking to the 2% loss rule is a mistake. The weak volume rally influenced the trades and the consequence is covering the shorts for higher loses. I let the emotion of continuously getting stopped out for 2% losses overrule the strategy and did not stick to restrict stops. In the end, these positions have greater losses. Setting strict stop losses are very important, and I do not want subscribers to break the needed discipline.
This reinforces the importance of sticking to the rules and trading the plan. We all make mistakes; it is part of trading and it happens to everyone. The key is to keep them to a minimum, and when a mistake is made, understand what was done incorrectly and learn not to make the same mistakes over again. If I stop out of a trade for a 2% loss, I do not consider that a mistake. That is not a mistake because I stuck to my plan. What I mean by a mistake is a deviation from a trading plan. Any time your step out of bounds, it is a mistake to correct before becoming a habit.
Here is the good news, (yes there is a bright side to this commentary tonight). Our mistakes have been very few in relation to the number of trades made. If you limit your mistakes and learn from them, you will do well in any market.
Let's talk about some of the positions we are stuck in so we can help everyone keep from making these same mistakes. MAMA, TPPP, SNTK, AMW, and NMKT are the long trades I am holding at considerable losses right now. Some short positions I am deeply concerned about include NBIX, POWI, WEBX, and DGIN. Let's explore the charts of some of these losers tonight and show you where we should have sold or covered. If you are in these stocks, these charts will not help you in the trade now, but I hope it will help you not to make the same mistakes in your next trades.
Hindsight is always perfect vision. When you look back at a chart, you always know what you should have done. We are never wrong; we would have always done the right thing, “Man I know I would have bought NT at .43 if I had only seen it then”. It is easy to say now but when it was .43, how did we know it would not drop to .25 and lose another 50% of our cash? We do not know at the time, but we kick ourselves when the stock goes up 2000% and trades above $8.00 15 months later.
The lesson is that we do not always have to trade. When markets are not cooperating, preserving cash is the key. If a cash position was entered on the Pizza Challenge this week, it will not make any gains, but it will probably be good enough to beat 80% of the entries.
The next Bull market is coming, it is difficult to say exactly when, but it will come and TWPD will be firing on all cylinders when it does by buying stocks of charts that have set up for big advances. Look at our 2003 record during the last mini bull cycle, we have done it before and we will do it again when the time comes. Will you have the cash to join us? Preserve capital, trade smartly, and stick to your plan during these rough times. If you stick to your rules, you will be in a good position when the real money is made.
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