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Wednesday, July 20, 2005
Market Recap
It was an amazing day in the stock market today. There were super earnings reports out after the bell yesterday and the market should have gone up on that news. Well, the futures were lower this morning, even after the good earnings reports. This of course was not expected nor was it logical. However, it was obviously a “sell the news” scenario to scare out the weak hands, only to have the market reverse and head higher. The DOW ended up by 42 points for a 100 point swing. The NASDAQ closed up 15 points and the S&P gained 6 points. Market internals were super with advances trouncing decliners and the TRAN gained a whopping 132 points. This is the most I have seen the TRAN gain in a long time. Like we have suggested before, we should be buying every pullback. This market has all the characteristics of a bull market. One of the things we commonly see in bull markets is exactly what happened today. The open is very week, only to reverse mid day and close very strong. Do your research and you will find this to be true. Small cap stocks usually lead the bull markets as well and the Russell 2000 small cap index has been on fire this year, making new highs again. The market is running on all cylinders and we are looking for stocks that can get us the fastest returns possible. We want to be fully invested long and we are working to get the STHQ portfolio to 100% long. I will have charts of all of the indices tomorrow with updates. There are no charts tonight due to the length of tonight's Part 3 “When to Sell” commentary. However, tomorrow, I will have another chart parade because there are so many charts we need to show you that are ready to explode up. Look for that on Thursday night.
Day Trades
Our day trades have been rocking the house lately. If you are a day trader, please check out the message board before the open for a list of stocks that I am day trading that day. They have been big winners lately. Today's day trades included the following big movers: DCEL, CKCM, NGPS, DIOD, PLAY, CELG, BOOM, and PLAB. Check the board and you will see that these were posted before they made their big moves. We had a feeling that this morning's gap down would result in a reversal and that is why I went ahead and posted the day trade watch list and then followed with the actual day trade post for each stock as I entered the trades. Normally, when we think the market will go down and stay down, I will not post day trades to the board. But in a bull market, buying when the weak hands are selling at the open can prove to be very profitable.
Five Effective Mechanical Trailing Stop Systems
The Ruler System
This is the most primitive and least technical method but can be very effective and, like all mechanical methods, takes the emotion out of the trade. All that is required for this system is a ruler and a print out of the chart of the stock being traded. For this system, you would use a 3 month chart and determine the trading range of the stock during this period. Printing the chart and using a ruler, you measure the distance between the high and low of the 3 month period. What ever that distance is will help determine where to place the trailing stop. An example would be, if the distance equals one inch between the high and the low of the 3 month period, then, as price moves up, you would move the stop up equaling one inch below the current stock price as originally measured after your initial purchase. If the distance of the range is ¾ of an inch at initial purchase, you would adjust your stop to ¾ of an inch below the current price after each days close. This system is only used when you purchase a stock on a breakout above the range and the original stop is never lowered. This systems works well with less volatile stocks because trading ranges are tight and the risk is lower. The more volatile the stock, the larger the trading range and with that brings the risk of a larger loss, if your stop is placed at the bottom of a loose range.
Price Support System
This is the stop loss method I prefer, however, it is very difficult to use when buying breakouts of pennants and flag formations. It is more suitable for the stocks that you buy on breakouts from a solid base or on stocks that pullback to support. The reason for this is normally, when buying breakouts of a flag or pennant, the stock has already broken out from a solid base. If you are buying the breakout of the flag, you have already missed the initial breakout from the base. Flags and pennants usually form during the consolidation of a recent breakout well above the initial resistance level which is now considered support. This breakout of the flag is an excellent secondary buy point but carries much more risk because the only solid support is well below the flag/pennant. The price support system would be better to use if you caught the initial break out of resistance. In this case, the support is now the old resistance (or breakout point), making for a minimal risk entry with a stop just under the support area and your entry price. This system also works well for stocks pulling back to support. After a stock breakouts out from a base, it will often come back to test that support. When it does, this is a good entry if you missed the initial breakout because you know that there is solid support at this level and that your stop should be place just below making the entry minimal risk.
Trading Range System
This system is based on a dollar figure and not percentage. In this system, we would use a 3 month chart and find the trading range much like the ruler method above, but instead of a measurement, we take the difference between the high and the low of the range as measured in dollars. For example, the 3 month range for XYZ is a high of $25 and a low of $20, difference being $5. You buy the stock at the breakout above $25 at $25.25 and place your initial trailing stop at $19.90, just below the low point of the 3 month range. As the stock moves up to $26.00, you move your stop up to $21.00. You keep moving your stop up trailing the closing price by $5.00. When the stock reaches $30.00, you move your stop up to $25.00. $25.00 was your buy point so you can not lose on this trade if it goes south on you. Remember, the trailing stop is always $5.00 in this case since the 3 month range was $5.00. If the 3 month range is $10.00 then that is always the trailing stop. As the stock moves up in price, you simply move the stop up, always trailing the closing price by the dollar figure of the 3 month range.
Volatile stocks will have wider stop loss ranges. As the trade improves, the sell stop is moved up accordingly. This type of stop is easy to use and maintain. However, there is a mathematical draw back to the system. This system is based on an arithmetic price difference and not a percentage, so as the trade improves in price the stop tightens. For example, your stock has moved from your original purchase of $25.00 and is now at $50.00. Using this method, your trailing stop is now $45.00. Your original stop was 20% below your buy price and now since your stock has doubled, your stop trails by only 10%.
Overall Percent System
A simple method for setting stops is to just pick a percentage of each trade that you are willing to risk and stick to it. Some may chose 5%, some may chose 10%. Right now at STHQ, we are trying to stick with 2 to 3% as our maximum loss. There are drawbacks to this system. It only works if you have a perfect entry (at support) if you are playing breakouts, then this may be too tight of a stop and as a result, you may be stopped out far too many times before the trade has a chance to develop. The tighter the stop, the more risk you have of getting stopped out before a big move. This tight stop leaves no room for the stock to breathe. Proper entry is key when having a tight stop system of 3% or less. One way to solve this is to expand the percent stop loss as the trade moves up. For example, you buy a stock at $40.00 and you set a stop loss at 5% under the buy point at $38.00. If the stock moves up to $50.00, you can expand your stop to 10% and move it up to $45.00. By doing this, you are giving the trade a little more breathing room and at the same time, locking in a profit of $5.00. You keep this 10% stop in place now for the life of the trade. Let the winner run, always moving the stop up to 10% under the closing price. A new high of $60.00, raise stop to $54.00. A new high of $70.00, raise stop to $63.00 and so on.
This method guarantees a profit while letting your winners run and giving them plenty of room to have shakeouts and pullbacks. This is by far the best method in my opinion and the one that I use personally in a bull market. The only drawback to this system is that it ignores natural support areas developed on the charts such as price, moving average, and trend line support.
Volatility Level Percent System
This is the most complicated and time consuming of the 5 stop loss systems presented here tonight but is the most logical one to use. It is tailored to the volatility of each individual stock. You must take each stock individually and decide, based on its 3 month range, where to place your stop. Again, using the 3 month chart, you will find the low and high of the range. Only this time, instead of using a blanket percentage stop, you will divide the low by the high of the range for each stock. You calculate each stop separately either using a calculator or on a spreadsheet.
Example 1:
Company=XYZ, High=33.10, Low=29.71
29.71/33.10 = 89.76%
If the stock moved up to $40.00, the stop would be raised to $35.90
$40.00 x 0.8976 = $35.90
The above example is a stock with very low volatility but lets take one with a wide range and is more volatile.
Example 2:
Company=ZYX, High=62.71, Low=47.12
47.12/62.71 = 75.38%
If the stock moved up to $70.00 the stop would be $52.77
$70.00 X 0.7538 = $52.77
Obviously, with greater volatility, our stop has to be looser then a stock with lesser volatility.
Conclusion
This concludes our series on stop losses. Test these systems on paper and decide which, if any, is the right one for your trading style. Remember, the important thing is to have a plan and stick to it. Having no plan in place to exit your trade is a recipe for disaster. Using a stop loss system will ensure that you stay in the game and live to trade another day.
STHQ Chart Index
If you go to the chart index in the left side menu, you can review and study charts that we have annotated for each stock listed in the past.
For New Members
For all of the new members with us, please make sure to read the link “How to use Bulletin” at the bottom of the Bulletin page on the website. It is critical that you know how to use this trading tool before trying to trade the stocks mentioned. The effectiveness of your trades will diminish if you do not completely understand how the information is presented.
Earnings Calendar
We have added the earnings link for each stock on the bulletin. To access the link for earnings, you can either use the link below or click the link on the bulletin for the corresponding ticker. Click the online bulletin in the left side menu for access to the earning calendar for each stock listed. It is not recommended to hold a position through earnings. You can always buy the stock back after the dust settles.
http://www.earnings.com
Stockcharts Listing
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http://stockcharts.com/def/servlet/Favorites.CServ...
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