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Trade Ideas for 9/2/08

Friday's market action really set up the case for the bulls. What a nice, gentle pullback in the major indices, and suddenly the Dow, S&P & Russell are well-positioned for price increases come Tuesday. So let's see if the bulls can take advantage of this setup.

BPOP popped big time on news Friday; I hope some of you were able to get a piece of the action. At one point the stock was up 27% before pulling back pretty sharply. The funny thing is, the initial reaction to the news was negative, so the stock actually started down for the day before beginning its incredible run. I've seen this a few times before: the market getting the initial reaction wrong. It's a gift, because then we have an opportunity to buy in. The general rule is to sell the news, so what to do about BPOP now is a bit tricky. It's 50/50 whether the run will continue; therefore I recommend selling 1/2 the position to book some of that profit.

The encouraging setups in the major indices may spell trouble for our other holdings, as lately basic materials have performed inversely to the major indices. However, these relationships are fluid; there was a time not long ago that higher oil meant higher S&P prices, for example. It's a matter of sentiment; if the market gets in a buying mood, very little can dampen its spirits. Both of our basic materials holdings do look good to me, so let's stay the course.

Current Holdings
Ticker	Basis	Closing Price	Perf.	Sell-Stop	Additional Exit Guideline	Chart
EGO	8.11	7.93	-2.2%	7.49	Stay the course	Chart
PCU	26.71	25.53	-4.4%	24.64	Stay the course	Chart
BPOP	7.67	8.15	+6.3%	6.89	Sell 1/2 to book profit and reduce risk.	Chart

Given that the major indices look good to me, it's no surprise that I found a raft of nice-looking charts for Tuesday, and I've listed a few that I like. A bit more than normal, but this reflects my enthusiasm. Of course, I could be wrong, so be sure to continue to manage risk; however, this is the first time in a while that I might give some thought to the Aggressive setup figures. Of the major indices, the Russell has performed the best, followed by the Dow and S&P. So if you'd rather not go for UWM, DDM and SSO are the UltraLong equivalents for Dow and S&P, and the unleveraged versions are IWM, DIA, and SPY. The NASDAQ-100 index actually looks pretty bad, but the NASDAQ exchange itself looks good—go figure.

Trade Ideas for 9/2/08

Ticker	Entry	Exit A	Exit C	Chart
UWM (UltraLong Russell 2000)	54.81	53.12	50.22	Chart
NDAQ (Nasdaq OMX Group)	33.23	32.21	30.99	Chart
LYV (Live Nation)	16.63	15.89	15.19	Chart
LVLT (Level 3)	3.54	3.29	3.18	Chart

Book 1/4 - 1/2 of NDAQ near 200-day moving average around 37.50. I currently own shares of LVLT and UWM.

Please refer to "How To Trade The Ideas" (right-hand side) to read this table.

Traders' Weaknesses

What is the hallmark of a successful trader? Many would say picking stocks well, or making a lot of money. Zecco Trading's community has a performance leaderboard that lists members' annualized returns. I remember in July, the guy at the top had a 300% return, trading names I'd never heard of. Is that an example of a great trader? Now less than two months later, his return is -99.1%. From hero to zero. (By the way, all those names were penny stocks in the $0.02 or less range.)

So is all trading necessarily live by the sword, die by the sword? No, there is another way, which is to manage one's risk well. It is disciplined risk management that is the hallmark of a successful trader, because managing risk will keep you in the game for the rest of your career; whereas picking the right stocks or making a ton of money carries no such assurance.

Of all the risks that must be managed, the biggest is yourself. You must make an effort to discover your weaknesses and then find a way to neutralize them, perhaps by implementing rules that you must follow. For example: don't buy more than 12 positions. Stop trading if you lose more than 3% in a month. Don't put more than 1% of your portfolio at risk on any one position. An excellent book on this subject is Dr. Alexander Elder's Trading for a Living.

I wanted to talk about one of my weaknesses as a trader. I have a fondness for the gold sector that can sometimes cloud my judgment. This got me in trouble earlier this year when gold hit $1,000/oz and I thought it was onto $2,000 right away, but instead it began Wave A of a massive correction. Just like now, I was overleveraged to gold, and in addition I committed a cardinal sin of trading: I pulled my sell-stops. I was so sure that gold was going to new heights that it took double my pre-planned loss for me to realize that I was wrong and subsequently sell. It was a sickening feeling to watch those stocks drop down, down, down from my sell-stop, which was already quite a ways down from my purchase price.

That whole period was a big blow to me, not to mention my account equity, and I felt like a loser. Not because I was wrong, but because I failed to manage my risks, which is basically what I do for a living. Not only did I take on too much exposure to the sector, I couldn't admit I was wrong when the evidence was right in front of me: price had fallen through my sell stops. This was a time in my career when Dr. Elder's book helped me a lot. I took double the loss that I should have. At least I actually sold my shares, and then put that money to use on trades that worked. My account actually hit an all-time high last week; meanwhile the stubborn holders who still can't admit they were wrong are down 20%!

A definition of insanity I've been seeing a lot lately is doing the same thing over and over again, expecting different results. As a trader, insanity is deadly, and I'm determined not to do insane things. However, in one respect I've already failed: once again I took on too much exposure in my personal account to the gold and basic materials sector, as I mentioned in my prior post. For my account, I would consider up to 4 positions in gold and related sectors within reason, but I had almost double that number. On Friday I sold 2 of my positions for losses in order to balance my risk. This was a move I had to make, even though the charts for gold and basic materials remain unbroken, because I had to compensate for the mistake of taking on too much risk. Many people are unwilling to take losses, and must wait for breakeven before they sell (this is why support and resistance work). But breakeven may never come, so the prudent remedy to overexposure is to sell at market to bring that exposure down to an acceptable level.

Now I can breathe a bit easier, sit back and see what happens. If gold breaks to the upside and hits the 200-day moving average, I'll be out with an overall profit. If gold falls below the pivot point of August 26th, I'll be out with a loss slightly higher than what I would normally find acceptable. I may even sell another position on Monday to bring my risk more closely in line with what I deem acceptable. In any case, I'll continue to watch the sector closely, because a run to the 200 will happen sooner or later.

B-POP

For those of you who got in on BPOP this morning, I forgot to mention that the target is the 200-day moving average of 9.71. I recommend selling at least 1/2 around that price, if it gets there. Pick a price below the average if you want more safety; above the average if you want to try maximizing your profit. Note that today's action is based on news of a sale of a business unit. Moves based on news don't tend to have the staying power as moves based purely on technical factors. So a little wariness is called for here.

Trade Ideas for 8/29/08

Tomorrow's the last trading day of the month, and the start of a long weekend. What will it bring? My thought is, continued strength in the major indices. Today's action in the S&P gave the edge to the bulls. Financials were so strong today—I didn't find a single one that closed in the red. As for the triangle I pointed out yesterday in the SPY, it was broken to the upside. Some texts on technical analysis claim that descending triangles favor downside. I've found that price is as likely to break down as break out of a triangle, so they are useless to me as a predictor of direction. What they do predict well is the likelihood of a significant move in some direction by a particular point in time, and that whatever direction is chosen should see continuation. (That prediction also comes with a target price, but this is really getting out of my comfort zone.) Since the market broke upward, today's move implies continued strength.

I wasn't paying a lot of attention to the general market, however. I was transfixed by the action in basic materials. For example, this morning PCU gapped up on the open, ran to our buy price, and then started a long decline. Sound to you like another stock we currently own? Especially given the timing of yesterday's post on this very scenario, I hope none of you purchased all the shares of PCU you had originally planned to at the buy price. Now, if any of you read between the lines of yesterday's post and actually shorted PCU at the open, fading the gap as it were, congratulations, and would you manage my portfolio? I myself was not that clever; I bought some PCU at 26.71, but fewer shares than originally planned. Why did I do it? Van Tharp observed that people don't trade the market; they trade their beliefs about the market. And this morning at 6:30 PT I believed in my read that basic materials was headed to its 200-day moving average. So I bought, adjusting for the additional risk of breakout failure by buying fewer shares. Let's not forget also that some stocks gap up and keep running. In the event, PCU gapped and crapped, but didn't violate the pivot low. Yeah, I could have purchased it at a more favorable price if I had waited. Speaking of which, whenever you see a sell-off as fast and as deep as today's (in all the basic materials sectors: miners, energy, precious metals), it is only a matter of time before the snap-back rally begins. Each move in a market is a move in price but also a move in time, and these need to be in balance. A sharp sudden move like this morning's disrupts that balance and is likely to be remedied by an equally sudden counter-reaction, which is what ended up happening. Andy Askey does some great work on the relationship between price and time in his blog; I encourage you to check it out. I took advantage of the counter-reaction to do a little buying myself. Here's a day trade in DGP:


I bought some DGP at a little after 12pm for 17.83, risking to the day's low, a spread of 0.17. These were the first green bars I'd since the first hour, and so I took a chance and bought the mini-breakout. I sold half just under 18—nearly a 1R return on that lot—and I still have the rest (DGP was also on my personal trade ideas list, and so this half-lot counts as a reduced-risk pullback purchase, for those keeping track). Anyway, I stick by my reading of the charts, namely that basic materials is riding a B wave rally (a.k.a sucker's rally) up to the 200-day moving average. This read remains valid: the pivot low of two days ago was untouched in all of the charts of basic materials stocks that I looked at (although it got real close in some cases) despite today's sudden sell-off. So if you own PCU and/or EGO, stay the course, but do get out if the stops are violated. It is more than possible that my read is incorrect; it has happened many times before and will again! If I do say so myself, I thought PCU and EGO fared particularly well in this sector, managing to gain on yesterday's close; this is encouraging. By the way, I misspoke in yesterday's update; the recommended stop for VISN (if you still own it) is 18.24. It's a shame that VISN was officially stopped out a couple days ago by a hair, because it is looking good to me again, and it wouldn't make a bad addition to the trade ideas list (hint, hint). I regret being so demanding of the stock; a more generous sell-stop was needed.

Current Holdings
Ticker	Basis	Closing Price	Perf.	Sell-Stop	Additional Exit Guideline	Chart
EGO	8.11	7.87	-3.0%	7.29, and optionally at market on a close < 7.49	Stay the course	Chart
PCU	26.71	26.23	-1.8%	24.64	Stay the course	Chart

I personally went a little overboard buying up a number of different companies in the basic materials sector: coal, energy, gold and copper (our very own PCU) at various points in the day. At this point I'm overexposed to basic materials, and so is our portfolio. However, if you wish for additional exposure, there are many ETFs out there: XLB, XLE, DIG, KOL, GDX, GLD, SLV, CEF, DGP. The safest way to buy is on a breakout past today's high (hopefully not on a gap up at open!), risking to the pivot low of a couple days ago. You could also buy at market, but do risk less. Meanwhile on the official list for tomorrow, I have Apple from yesterday and a couple of "banks." These stand to do well in case of a rally in the S&P, and will provide our portfolio with some much-needed exposure to other sectors.

Trade Ideas for 8/29/08

Ticker	Entry	Exit A	Exit C	Chart
AAPL (Apple)	177.51	171.65	169.66	Chart
BPOP (Banco Popular)	7.67	6.99	6.71	Chart
JOSB (Jos. A Bank Clothiers)	27.01	25.86	24.99	Chart

Please refer to "How To Trade The Ideas" (right-hand side) to read this table.

Update

New signal added to ideas for 8/28 - please re-read post

Trade Ideas of 8/28/08

Another day of back-and-forth. Both SPY and SDS once again look about even. I thought the bears had a chance to seize control, but instead it's more consolidation. However, a pattern of declining tops is forming on the S&P, while support at the mid-126s has been tested a lot. I'm not into drawing triangles on the charts, but this one is of note, because the slope of the down angle just has that look. Today's less-than-spirited fightback from the bulls only serves to make the pattern more clear. Meanwhile it looks like there might be rapid movement upcoming in the basic materials sector: oil, mining, coal, precious metals, etc; which I think is more deserving of attention than the general market.

Today VISN was just stopped out on a close below 19.00. My intraday chart shows VISN closing at 19.07 but I'm going with the published closing price on Google Finance and Stockcharts. If you still hold it, stop is at 18.49. EGO gapped up at the open and then faded. As I mentioned in my prior post, selling the gap up is a strategy certain traders employ to great success. Therefore, we are wary of gap opens. I will track buys if prices gapped and ran into the buy price (but not if it gaps over the buy price), however, it is not to be interpreted that I would go for such a purchase, certainly not at full risk. Despite the gap-and-crap, EGO, and the gold sector in general, looks primed for a run of 10+%. Watch your stops, though—gold is the hardest sector to trade.

Current Holdings
Ticker	Basis	Closing Price	Perf.	Sell-Stop	Additional Exit Guideline	Chart
EGO	8.11	7.81	-3.1%	7.29, or at market on a close < 7.49	Best would be to see price get higher than 8.15, but it's also OK if it hangs out between between 7.80 and 7.50 for a few hours. I'd be worried if it got below that for any significant length of time.	Chart

Not many charts look good to me for tomorrow (outside of gold, which we have exposure to), but here are a couple that are OK.

Update: basic materials just look too primed for a swing run, so I'm adding one more trade idea. Don't take PCU unless you can accept the double exposure to basic materials— it could move in sympathy with EGO.

Ticker	Entry	Exit A	Exit C	Chart
AAPL (Apple)	177.51	171.65	169.66	Chart
SRS (UltraShort Real Estate)	94.74	89.99	88.13	Chart
PCU (Southern Peru Copper)	26.71	24.64		Chart

PCU target price is the 200-dma around 32.83. Sell 70-100% upon attaining the 200.

Please refer to "How To Trade The Ideas" (right-hand side) to read this table.

Beware of Breakouts at the Open

This morning, fully 4 out of my 16 trade ideas, including yesterday's "official" trade idea EGO, broke out above my buy prices within 5 minutes of market open. The screenshot below shows 10-minute charts for each of these four tickers. These charts span yesterday and today, so refer to the middle of the chart (8/27 on the x-axis) to see price action at today's open.


My trading strategy is based on buying breakouts, and I will happily buy them any time of day, except at the open. Breakouts at the open have a higher chance of failure for a number of reasons. At market open, trading desks are processing all the orders that people placed the night before and before they went to work. Volume may be high, but unlike at other times of day, this volume may not be representative of ongoing buying interest—more like a one-time charge. The market hasn't had a chance to get into a rhythm, so in a sense, the action at the open is out of context. One simply doesn't have any assurance whether there will be follow-on buying interest, or if instead the breakout will fail. Indeed, one strategy that traders use is to fade (meaning sell) the opening breakout, especially if it's on a gap up.

By the same token, some of the biggest winners break out at the open, don't pull back very much, and just keep going. So what to do? Given the uncertainty of buying an opening breakout, the right thing to do is to reduce risk. How much to reduce risk is an individual decision. The safest strategy is to not enter your orders until well after market open. The Real Time Trader recommends waiting until 10:15 before entering orders. You miss out on some winners, but you also avoid the gap-and-crappers.

Another strategy is to wait to see how high the stock goes, wait for a pullback, and then buy a breakout to the new high. Notice how in the screenshot the high bar in each of the charts for the first 30 minutes is the second bar formed for the day. Instead of buying at the preset breakout price, at 10:00 AM or later put a buy order above the highest price achieved in the first 30 minutes (assuming the market hasn't run away already). You end up paying a higher price, but you also reduce the chance of buying a failed breakout. Don't forget to adjust the number of shares you purchase when you do this to account for the wider margin between the entry and exit prices. Also, because a lot of demand was burned up by the initial breakout surge, consider reducing the percentage risked, to reflect the lost profit potential. A more difficult, more risky, but by the same token potentially more lucrative tactic is to buy the pullback. Wait for any gap to fill (meaning after gapping up, price goes all the way back to the prior close); better yet, wait until lunch time or later, to put in an order to buy. Make sure you reduce your risk, preferably by 50%, if you pursue this tactic. There's no guarantee price won't keep falling down to the sell-stop after you buy; there's also no guarantee that price will even pull back at all after the initial gap up.

Let's take a look at what happened to my 4 tickers today. LO broke out and after 10 minutes immediately rotted. EGO and TGC gapped up and then began a gradual descent. The only winner so far is CELL, which broke out and was able to sustain its price level. One lesson to take away is that if you're going to take on the risk of buying the opening breakout, try to limit yourself to breakouts that don't form gaps at the open, as TGC and EGO did. A gap is a space between the prior day's close and the current day's open. Gaps have a higher likelihood of being faded, resulting in the "gap-and-crap." Another risk reduction method is to limit yourself to a fixed number of charts. For example, buy at most 1 or 2 tickers in the first 15-45 minutes of trading, and for each of these consider reducing the number of shares purchased. As Brian Shannon of Alpha Trends is fond of saying, risk management is job #1.

Trade Ideas for 8/27/08

The market may have closed on a high note, but I think the bears have put themselves in prime position. The SDS hasn't looked more poised to pop since... well, since 12:00pm today when the ball was in the bears' court and they whiffed it. Let's see if they can connect tomorrow.

VISN managed to get to the range I mentioned yesterday within the time requirement, so I think it looks much healthier today. Odds certainly are higher that the correction from 20.01 is done.

Current Holdings
Ticker	Basis	Closing Price	Perf.	Sell-Stop	Additional Exit Guideline	Chart
VISN	20.01	19.20	-4.0%	18.24, or at market if close < 19.00	We want to see higher highs and higher lows on the intraday chart. We want to see price clear 19.42 quickly, or at a minimum stay mostly above 19	Chart

EGO from yesterday looks terrific, and let's give the short side a shot.

Ticker	Entry	Exit A	Exit C	Chart
SDS	67.79	65.99	64.37	Chart
EGO	8.11	7.49	7.23	Chart

Please refer to "How To Trade The Ideas" (right-hand side) to read this table.

Exit Strategy

While newcomers and the financial media focus on entry prices for stocks, seasoned market participants recognize that the exit is by far the more important of the two. The exit is what allows us to achieve the most important goal of a good trading system: to preserve capital. When we first enter a holding, we put a sell-stop at the exit price, and this bounds our risk. That risk, in dollar terms, is the difference between the entry and initial exit price, multiplied by the number of shares purchased. Because this amount was one we had deemed acceptable to potentially lose on that particular trade, we are free to let go of the monetary aspects of the trade and instead focus on the job at hand: to optimize the trade.

Optimizing the trade means balancing two goals: maximizing profit potential and minimizing risk. The profit potential aspect depends on the market environment, which is out of our hands. What we as traders can control is our risk appetite, which translates ultimately to managing the twin bugbears of greed and fear. In this discussion, I will focus exclusively on uptrends when I talk about trending markets. In a downtrending market, just assume I am talking about SDS, which goes up as the market goes down, or your contra investment vehicle of choice.

In an uptrending market, profit potential is high because prices tend to continue moving up, and the risk of the trend ending is low. Because risk is low, the best strategy is to let the market lead rather than using target prices, which will invariably be either too high (greed) or too low (fear). If you have a system that consistently predicts the peak of uptrends, then you are just too good, and also I don't believe you. In uptrending markets, the trade optimization strategy is simple: use the definition of a uptrend (that is, higher highs and higher lows) to move sell-stops up as the lows get higher and higher. We will recognize that the trend has ended upon seeing a lower low, upon which time we exit the trade. It is a necessity to accept the fact that we are not aiming to get out at the tippy-top. Rather, the aim is to get out at the low that is closest to the top once the trend finally does end and the stock begins to decline. What one considers the top of the trend depends on one's timeframe. A daytrader may view the mid-morning spike as the top. A long-term Elliot Wave trader would disagree, saying that October 11, 2007 is the top.

Let's do an example trading my Aggressive system. Say we enter CWEI at the breakout on May 2nd, 2008 at 64.61, with our initial stop at 60.99 near the May Day low.


On May 6th CWEI formed a higher low and bounced to close at a new high, all in one day. The stock pivoted, meaning it formed a low and then subsequently a higher high. Thus, our stop gets moved up to just under that day's low at 62.49. Following this principle, the stop is moved to 67.35 (the May 8th low) on May 9th when a new high is reached. On May 19th the stop goes to 70.99 (the May 15th low), and to 76.49 on the breakout of May 30th, recognizing the May 22nd low. CWEI retraces a tiny bit, does a one-day outside reversal on June 5th and that means our stop is now at the low of that day, 94.22. Notice how each of the lows jumps out of the chart. They are all notable (but not severe) perturbations in the uptrend. We are not putting a stop at the low of each day, but being judicious based on the look of the chart. June 17th our stop is moved to 103.49. And that is the price at which we exit CWEI on June 26, the day of the first lower low of this run. By the definition of trend, the lower low means the trend is over. The tippy-top of this trend was 121.50, and although our exit price is $18 away, we are proud of ourselves for getting out at the highest pivot low closest to the peak. (There are ways to systematically get closer to the peak, but that would unnecessarily complicate this talk.) Our profit is 10.74R, where R represents the dollar amount we put at risk on this trade. This systematic method of moving stops up, rather than trying to determine a target price, means that profits are able to grow to heights that we couldn't have imagined, buoyed by a strong uptrend. We also do not take on the risk of holding the stock too long, suffering losses in the ensuing decline due to a too-high target price. We let the market lead us, rather than trying to lead the market.

All of this is thrown out the window during trendless markets. Because most of technical analysis is based on prices trending, systems that employ technical concepts start to malfunction when there is not much of a trend. In such an environment, the task of optimizing trades errs to the side of risk minimization. Profit potential is no longer high because price is buffeted by a fierce tug-of-war between buyers and sellers, getting nowhere. In other words, whipsaws are the norm, and any sustained price action is short-lived. People say day trading systems work well in trendless markets. In fact, day trading systems work even better in trending markets. It's really that all long- and medium-term trend-based systems start failing, and the only ones that work at all are very short-term systems such as ones based on day trades. Participation in such a market requires a close relationship with one's gut because in an environment of constant risk, the slightest sign of trouble needs to be recognized as such and factored into the exit decision. Constant monitoring and re-evaluation of market conditions, as well as early exits, is rewarded. Such impatience is punished with mediocre returns in trending markets. In fact, the percentage return is about the same in trending and trendless markets, but a return that seems mediocre in a trending market is spectacular in a trendless market.

One notable difference between trendless and trending markets is that breakouts are more dramatic in urgency and also have a higher chance of failing right away. Nevertheless, the fact remains that they do occur and can be traded for profits. They simply need to be exited more quickly. One strategy I use is to lie in wait for a breakout and then exit partials on the actual breakout. If the breakout occurs below the stock's 50 or 200-day moving average, I often set a target exit for up to 100% of the position near that moving average. This is one time that target prices provide me with a compelling risk/reward since the chance is significant that the moving average will reject the breakout. If the breakout is sustained, perhaps marking the start of a new trend, I still have a portion that can ride it. If the breakout fails, at least I managed to get a piece of it while the getting was good. This has been my strategy for the past months, and it has worked for me—I'm beating the S&P by a healthy margin so far this year.

The most important part of participating in a trendless market is to keep the faith. At some point, the new trend will emerge. A good trader must have the recognition and the courage to participate, because a trending market is payment for enduring the hell of the trendless environment. There is always the option of not participating in a trendless market. While there is money to be made, primarily by playing breakouts, the danger element means a high chance you'll just lose your money. It is definitely not the type of environment in which to get your feet wet if you are starting out. You will have your hat handed to you; and if you do manage a few successes at first, expect that hat to have a head underneath it. Trendless markets are the worst environments in which to get overconfident. They are the worst environments to get started in. And they are the worst environments, period. By the way, I've read that markets are trendless about a third of the time. It doesn't seem like the percentage should be that high, but it's also possible I blocked out the memories of those times.

Trade Ideas for 8/26/08

Maybe tomorrow we'll know which direction the market will take. It bent but didn't break today. Meanwhile TTI was stopped out on a close below 21.57.

I'm having a dilemma about the Current Holdings table. The original purpose of this blog was to share a bit of the chart research I do each night. That's tickers, entries and initial exits. But initial exits can't stay at that level forever; they need to move up to lock in profit, and so I created the Current Holdings table with my suggested sell-stops. Thing is, in reality I've been selling discretionarily in this market. I haven't been letting the stocks move against me very much. A bit of an itchy trigger finger. For example, I mentioned my purchase of KRY yesterday. If you look at the chart of KRY it doesn't look like I'm doing that well. But after getting in at 0.94 Thursday I sold 1/3 Thursday and the balance Friday at prices that weren't near my formal stops of 0.71 and 0.94. I fear that the Current Holdings table is implying a different exit strategy than the one I'm actually using, which I would describe as nimble and impatient. For example, this morning I started out with 8 full positions from the prior session and by the end of the day I had 1 full position and 2 half positions, with only 1 of those original 8 having been sold on a bona fide stop-out.

My unwillingness to bear risk for long is a function of the transitioning market environment we're in, where a trend can't last three sessions. As a result I'm looking for stocks to go up or they're out, and I'm treating all my holdings with suspicion. Once the market picks a direction, this will change. But for now, I fear that providing just a formal sell-stop for each holding is actually hurting more than it's helping all of you, since a strategy of proactive selling has been working better for me than a strategy of patience. So I'm going to add a guideline that provides additional criteria on when I would consider an exit. I'll continue to consider the position a Current Holding until the sell-stop is actually breached, just to be fair.

It must be emphasized that in a trending market, this squishy exit strategy is a ticket to mediocre returns. But different market conditions require different trading systems, as I mention in How To Trade My System.

Current Holdings
Ticker	Entry Price	Closing Price	Perf.	Sell-Stop	Additional Exit Guideline	Chart
VISN	20.01	18.69	-6.6%	18.11	We want to see evidence that the correction from the 20.01 high is complete. Consider dumping if it isn't around 19.20 or higher by 1PM ET. If it clears 19.65, new stop at 18.49.	Chart

I also wanted to experiment with giving up to two signals each day, and making sure they're signals I like rather than carrying over the ones from the day before just cuz they're still valid. Valid doesn't mean I like them very much! The blog's only been around for a week, so it's natural that things'll be shaken up!

Ticker	Entry	Exit A	Exit C	Chart
MHK	69.16	66.27	65.57	Chart
EGO	8.11	7.67	7.23	Chart

For MHK, consider selling 1/4 - 1/3 if it gets to the 200-day moving average of 72.36

Please refer to "How To Trade The Ideas" (right-hand side) to read this table.

Trade Idea for 8/25/08

I'm a little scared about the upcoming week. I think we've reached a critical juncture, and soon the market is going to make a strong move one way or the other. Right now it's 50/50 as to up or down. Remember when I said that the SDS was looking better than the SPY? Now they are both looking equally good (or bad). There are four market technicians that I follow, each with his own unique way of looking at the market, each with his own trading timeframe, and here is what they have to say (you can get to their sites by going to Sites I Frequent on the right-hand side of the blog):

Technician	Outlook
The Real Time Trader	"after completing an a-b-c correction...the SKF has bounced to the 50 day and sold off - an a-b-c bounce. That is EW [Elliott Wave] hell - the abc of an abc - a 50/50 shot either way. Which way will it go."
Andy Askey of PTV-Investing	"...The range from October to March is about to complete. It is possible the market is waiting for this cycle before moving up. Or it could collapse [this] Monday. Play it the way it breaks."
TK of Trading with TK	"That's the dilemma of the market. That's why it's 50/50. I don't know — it could go either way....There's a reason to bet up, and there's a reason to bet down."
Brian Shannon of Alpha Trends	"[The SPY getting above the 131.50 level] would perhaps pave the way for higher prices"

Seems like most of us are in agreement that the market is about to make a move, but who knows which way it will be? Our job as low-risk traders is to let the market tell us first. If the SPY should go above 131.50, that would send a message that buyers are in control. Fall below 126 and sellers are in control. As always it's up to you whether you want to place any bets. For me, I'll stick with charts that look strong, but I'll be on high alert. I'll be ready to sell all my positions if things start looking bad on Monday.

Enough theory for now, let's get to the trades. A reader who is also on Zecco Trading (where trade data is viewable to the community) noticed that I bought KRY on Thursday, but it didn't appear in the trade ideas list. The reason is, I don't share all my ideas. I share at most one new idea each day. This idea isn't necessarily going to be the best one on my list, but it will be a liquid stock with what I see as a good balance of reward and risk. If you want more signals, email me and I'll tell you what I'm looking to trade, or you can start a trial subscription with The Real Time Trader. There's a lot of overlap between his signals and mine because the setups I look for are based on what he taught me.

As for our trades, VISN got as high as the buy price between 9:40 and 9:45 Friday and then dropped from there. My order didn't execute, but I know that some others' did. If you got in VISN with the Aggressive-style exit, you'd have been washed out within an hour. Never forget that the market is mean. The Conservative-style position is still alive, but I would get out if it closes below Friday's low. TTI pulled back along with all oil & gas stocks, and I thought that pullback was a bit far. I would get out if it closes below Friday's low as well.

Current Holdings
Ticker	Basis	Closing Price	Perf.	Exit A	Exit C	Chart
TTI	22.20	21.87	-1.5%	20.88, and at market if it closes < 21.57		Chart
VISN	20.01	19.20	-4.0%	N/A - out at 18.99 for -1R/-5.1% loss	18.11, and at market if it closes < 18.50	Chart

As for Monday, given what I said earlier, it's go big or go home. If the market roars, the biggest beneficiaries will be the most speculative sectors. So that's what I'm looking to play.

Ticker	Entry	Exit A	Exit C	Chart
SOL (ReneSola)	19.71	17.86	16.99	Chart

Please refer to "How To Trade The Ideas" (right-hand side) to read this table.

Important

Significant revisions to How To Trade My System. Please read it if you plan to trade my ideas, or if you are trying to develop (or don't understand the concept of) a trading system.

In Defense of Technical Analysis

Tonight I jumped into a heated discussion on the Zecco community forums called "An Argument Against Trading." I understand the theoretical basis for technical analysis, which underpins my trading, but I forget that others don't, and I forget that many view it as a kind of voodoo. Even many who employ it have no understanding of or curiosity for how it works.

Simply put, technical analysis is the study of human behavior in a market context. Academics will call it behavioral economics. Your classic stock chart is a representation of how groups of people have evaluated a particular good (in this case a financial instrument) over time. A chart therefore depicts a series of supply and demand data.

On the other hand, fundamental analysis is the study of the good itself. This is an example of classical economics, which assumes that humans are rational beings and therefore the human element may be abstracted out of the equation. Classical economics is flawed. The most important factors in the market are the market participants themselves, who have free will, who can do unpredictable things (yet for some reason they tend to do things in predictable ways — go figure). Who cares what it is that they're trading!

Here is an excerpt from my post on the forum:

I observe that markets correct 33-66% of any advance, and this is an observation that is true for any time frame, and for any market (stock) no matter how solid fundamentally. Why? Because the ultimate irreducible is the human element: prices are motivated by groups of humans making evaluations, from the millisecond level to the span of a generation. The fundamental flaw in fundamental analysis is the amount of emphasis placed on a merely ancillary entity: the good being evaluated. In fact the good in question is irrelevant - it could be securities, houses, tulips; it is the market participants' actions that are invariant from market to market. The field of economics has begun to recognize this mis-emphasis with the advent of behavioral economics....But I digress; point is a LTBH strategy will end up giving back 1/3 - 2/3 of high watermark gains, no matter the timeframe. And that is ridiculous.

Meanwhile, a skilled trader

• makes moves based upon empirical observations of raw supply and demand data
• holds that supply and demand follow repeated price patterns (trends)
• takes calculated risks based upon these observations, keeping losses to a fixed maximum per trade while allowing profits to grow to any amount (the concept of a sell-stop)
• thereby allowing profits to grow at a greater rate than losses

and, I might have added, keeping drawdowns minimal. Investors focus intently on percentage return, but the other important factor is the variability of those returns. For example, the return in the S&P for 2007 was 4%, which seems OK, not great; but does 4% in any way, shape or form capture this price action?


There's very little assurance that that +4% return wouldn't turn into a -4% return in a month — it's all over the place. That it finished at +4% instead of -4% is a fluke. On the other hand, here is a chart of my personal return for 2007:


So much less variability — notice the slow but steady growth in accumulated profit. An interesting thing happens when you compare my return to the S&P. Every time the S&P fell, so did my return; but whereas the S&P gave back at least 33% of each upward move, I did a much better job of protecting my gains. And that's despite having stepped into a landmine called Biogen IDEC mid-December. Protecting your gains is the primary goal of a good trading system. Full disclosure: I achieved this performance thanks in large part to trading with The Real Time Trader. By the way, if the chart of the S&P return resembles your return, then you need help. I urge you to develop a system that allows you to build profit steadily over time. You could try mine, or better yet take a look at Sites I Frequent on the right-hand side of this blog and get some perspectives from other traders. Confession time: here is a chart of my return for one typical year back when I was a long-term buy-and-hold (LTBH) investor:


A year's worth of hard work, dozens of discounted cash flow calculations — for less than nothing!

Trade Idea for 8/22/08

The new trends have really announced themselves today. Following on the previous days' action, gold and oil have solidified countertrend moves. I don't believe the absolute bottom has been registered in these two sectors — the downtrends, while vicious, are just too new. So my guess is that we'll rally to the 200-day moving average and then reverse again. Don't get too comfortable! Meanwhile, the chart of SDS (inverse S&P 500) is now looking better to me than that of the S&P. As we head into what may be a turning point, odds are not looking good for a rally in the general market.

Capitalizing on strong oil, some of us may have been quick enough to snag some of yesterday's idea, TTI. It gapped up on the open above the entry price, opening 8 cents higher at 22.15. It hit a high of 22.76 and has been pulling back since. My guess is it will pull back a bit more, then pivot. I didn't buy any as I don't like to get involved at the open — been fooled too many times I guess; I almost bought a reduced portion on a pullback to 22.20 about 20 minutes later but chickened out, pulling the order at the last minute, watching as it hit 22.16 and then took off for good. Stocks do gap above the entry prices; I discuss a few strategies for dealing with this scenario in the article How To Trade My System. Anyway, for purposes of tracking the performance, I'm going to assume a makeable entry price of 22.20. If you bought in, move stops to 20.88 regardless of whether you traded in an Aggressive or Conservative style.

Current Holdings
Ticker	Basis	Closing Price	Perf.	Exit A	Exit C	Chart
TTI	22.20	22.50	+1.4%	20.88	20.88	Chart

As for STEC and LVLT, the one never got going, and I can't say I like the chart of the other anymore, so how about something completely different.

Ticker	Entry	Exit A	Exit C	Chart
VISN (VisionChina)	20.01	18.99	18.11	Chart

Please refer to "How To Trade This System" (right-hand side) to read this table.

Trade Ideas for 8/21/08

A little bit of relief today, not enough to register even a single digit gain in the major indices, but I consider that quite a feat given how bad the sell-off was yesterday and also given today's early headlines of financial gloom and doom. In fact the XLF (the financial ETF) led. Not only that, there were huge breakouts in one of the most speculative sectors: the solars. A rally in the solars often precedes a rally in the general market because it indicates a high appetite for risk and the presence of momentum traders. Basic materials also did well today.

From its chart LVLT looks to be on its last legs, but I'd actually rate its chances highly. The longer the consolidation phase, the more explosive the subsequent move. Of course that move could be up or down; guess correctly and maybe make a bundle. Guess wrong and lose at most the amount you decided to risk. I'm more enthusiastic about LVLT than I am about STEC, which pulled back kinda far and closed near its lows. Still a valid signal, so it's staying on. Today's new addition is TTI. Oil and gas stocks have started to reverse, and this chart looks like one of the safer ways to play this potential trend. I only plan to offer at most 3 trade ideas on any given day (1 of which may be new), so if these stay beneath their Entry and above their Exit C prices, you'll see them again tomorrow.

Ticker	Entry	Exit A	Exit C	Chart
LVLT (Level 3)	3.43	3.07	2.93	Chart
STEC	11.21	10.67	10.34	Chart
TTI (TETRA Technologies)	22.07	20.88	20.21	Chart

Please refer to "How To Trade This System" (right-hand side) to read this table.

How To Trade My System

Many people think that the key to success in the stock market lies in picking stocks. I used to believe that, too: find a few winners and then I'd be a success. In fact, picking stocks is one of the least important aspects of a trading system. Once you have a great pick, for example, how do you figure out how many to shares to buy? In the big picture, the answer to that question is so much more important than anything specific to the trade idea itself (e.g., ticker, exit, entry). When I discovered this fact, it changed my return from one that went nowhere to one that steadily rose over time. For more on how to put together a complete system, I urge you to read Van Tharp's Trade Your Way to Financial Freedom. While you wait for your copy of the book to arrive, you can read my post on how many shares to purchase as well as The Real Time Trader's take on the same subject. There is no substitute for Tharp's book, however. It has been the most important book on trading I've ever read.

This post will cover the purpose of my system, my trading concept, what my setups are, how to read the table with the Entries and Exits, how to choose between the Aggressive and Conservative exits, how and when to place buy and sell orders, what to do if price is above the Entry or below the Exit prices, and how many positions you should own. The subject of when to sell is the subject of my post on exit strategy.

My stock trading system is the system I use to make money in the stock market. The #1 goal of my system is capital preservation. The #2 goal is to make a steady income. The #3 (and by far least important) goal is to hit the jackpot on a few trades. I strongly believe these should be your goals as well, and in that order.

The theoretical basis for my trading concept is Elliott Wave theory, which in turn is based on the theory that prices trend. My system trades equities on the US markets that are more likely than not to experience price increases in the coming days. Three common setups I look for are small pullbacks in a strong uptrend, lengthy consolidations, and reversals in a downtrend. This list of setups also happens to be ranked in terms of likelihood of success!

The cornerstone of each setup is an entry and an exit. The entry price indicates the minimum price level at which the stock must trade before we buy it. We are not trying to buy at the bottom here — leave that to the daredevils who don't care about preserving capital. I expect that a large percentage of the trade ideas I generate will not make it to the entry price; because we are not involved, these end up being failed signals rather than losses. Do not buy the stock unless it is trading at a price equal to or greater than the Entry price! I have no power to predict where stocks will go. I can only identify promising setups, but even then I need evidence that the stock can deliver on that promise. This evidence comes in the form of positive price action — if the stock price can breach the entry level, that proves to me that there is demand and potentially momentum for that ticker.

While the Entry price is straightforward, you might have noticed that there are two Exit columns for the signals. Exit A indicates the Aggressive exit, and Exit C the Conservative. In fact, the tables describe two slightly different trading systems. The Aggressive system is optimal for trending bull markets, while I use the Conservative system in weakly trending bull markets and bear markets. Neither of these systems does well in non-trending markets. For that, you will have to look elsewhere, such as a day-trading system. So whether you choose to use Exit A (Aggressive system) or Exit C (Conservative system) depends on market conditions — but it also depends on you. In a strongly trending market, one makes more money with the Aggressive system, and at the same time one doesn't get stopped out that often. However getting stopped out early is unavoidable; that's just the price one pays for being able to buy more shares for the same dollar risk. That means you have to be OK with getting whipsawed more frequently using the Aggressive system no matter what, as stocks will go below the sell-stop price, forcing you to sell, and then rebound to new heights - without you. This is less likely to happen when using the Conservative exit because the latter price level represents a more key level of support. While I've gotten whipsawed in a matter of minutes using the Aggressive system, the fastest I've ever gotten whipsawed using the Conservative system was 4 days.

There are other trade-offs involved. One big downside for the Conservative system is that for the same amount of risk, you can't buy as many shares. For example, given the following trade idea:

Ticker	Entry	Exit A	Exit C
ABC	3.36	3.23	3.07

if I'm willing to risk $500, I can buy 3,846 shares using the Aggressive figure ($500 / [3.36 - 3.23]) but only 1,724 shares using the Conservative figure ($500 / [3.36 - 3.07]). But you may be able to compensate for this. Because you are less likely to get stopped out early on the Conservative exit, you may be willing to risk more money on it. Unfortunately there is no way to get something for nothing here — although the Exit C represents a deeper level of support, the market could still find its way down there, and then you'll be out more money. One variation is to hybridize the two exits, creating yet another system. In this system, use the Conservative exit as the absolute sell-stop, representing the maximum risk you will bear for that particular holding. Then use the Aggressive exit as the market-on-close (MOC) sell-stop. Under this scenario, sell the stock if at any time it goes below the Conservative exit, and also at the market price if it closes (or is going to close) below the Aggressive exit. Disregard intraday breaches of the Exit A price. This is up to you.

To buy stocks in my system, I recommend you use stop-limit buy orders through your broker. Note that you are buying stocks as they are moving up (buying on strength). A stop-limit order consists of two numbers: a trigger price and a limit price. The trigger price is the minimum price at which the stock will trade (or be bidded/asked - see What To Look For in a Brokerage for a discussion on these variations) before an order to buy the stock at the limit price is executed. The advantage of stop-limit over a plain stop order (a.k.a stop-market order, which becomes a market order upon hitting trigger price) is that you put a cap on the price you will pay for the stock. This is especially important for stocks that have wide bid/ask spreads. For example Mastercard (MA) routinely has bid-ask spreads of 50 cents. A buy stop order at 237 might execute at 237.50. If instead you used an order of buy limit 237.25 stop 237, the maximum you'd pay is 237.25 per share. The downside is that if price action is very strong, your order may not get filled as the market price jumps right over your limit price. For example MA could gap from 237 to 237.40 and then keep going, leaving you with no shares to show for your effort. Make sure that you leave enough room between the stop price and the limit price so this doesn't happen often.

Once your buy order executes, place a sell stop-limit order to protect your capital. Use the figures in the Exit column as your guide. As the position goes higher, I will adjust the sell-stop upward, thus locking in profits. Make sure there is a sell stop-limit order in force each day you carry the position. The point of all of this is that if the stock is trading at or below your exit price, you need to exit the stock. Remember: the #1 goal is to preserve capital. It is not to make money, it is not to make a ton of money, it is to keep what money you already have. That's why it is imperative that you sell your position if it goes below your sell price. I recommend that you enter your buy and sell orders after the market has opened and definitely after the stock has traded a few times (assuming you have access to that data). This is so because sometimes the first trades of the day are not in line with the market, and market makers have the leeway to make questionable calls that may result in unexpected losses for you.

What should you do if the stock price is greater than the entry price, and you're not in it yet? Should you buy? There is no easy answer to this question, and it's also not an uncommon occurrence. It's really a judgment call. You can always forget about it and focus on other ideas. If you decide to buy it, I advise you to buy fewer shares. Use the calculations in How Many Shares to Buy using the new entry price and consider risking a smaller percentage. You can also wait to see how the stock fares and perhaps buy at a different price - maybe on a higher high, or waiting to see if it comes back to the initial Entry price. In the latter case, I recommend that you reduce your risk dramatically because you are NOT in the same position as if you had purchased the stock in the first place. You have the advantage of seeing subsequent price action - for example you now know the stock didn't continue going straight up after hitting the Entry price. You may also be buying on a short-term downtrend. The risks have increased, so you must compensate by risking less.

What should you do if the stock price goes below the level of the Exit price, and you don't own any shares yet? First, if the price is below the Exit C price, the stock idea is a non-starter, period. Strike it off the list; it is no longer valid. If the price is below the Exit A price, and you are still interested in owning the stock, then the new Exit A price is the low price of the day (or a few cents less, if you want to give yourself a little room). This may mean you need to recalculate the number of shares you buy. As always, don't buy the stock until it rises to the level of the Entry price; the only things that change as a result of this situation are the stop-loss price and the number of shares to purchase.

Finally, I wanted to cover how many positions you should have at any time. The rule of thumb is a maximum of 12 full positions. You don't want more positions than you can keep track of, and you don't want to be unduly exposed to risk. One thing I do each day before the market opens is figure what my total exposure is. For each holding I subtract the sell-stop price from the closing price, multiplying that by the number of shares I have. This gives me the amount at risk for each holding. I don't want the sum of that to be more than 6% of my portfolio, and definitely much less than that in a tough market environment. That amount represents the most I stand to lose - assuming I have the discipline to sell my holdings once they fall below the sell-stops, and also that the market doesn't nosedive the next morning.

Trade Ideas for 8/20/08

Further broad deterioration today, with lower lows in the major indices. The general market has pulled back to a critical point. If we don't see a reversal tomorrow, to my eyes the concept of the mid-summer rally looks to be in peril. If it turns out the rally is over, that's a testament to how bad things are — and how very bad they will get. With reference to the SPY chart, note how far we still are from the 200-day moving average. For this rally not to have the legs to get within spitting distance of that moving average would mean incredibly deep damage in the market. For those that read Elliot waves, note how the rally from mid-July has traced a simple wave 1, complex wave 3, and we are in the middle of the C portion of wave 4 — assuming a 5-wave countertrend. This could very well turn out to be a 3-wave countertrend instead, meaning no further upside. It will all unfold in the next few days. I read Andy J. Askey's PTV-Investing blog, and it's probably no coincidence that he highlights August 22nd as a potential reversal day. So stay tuned.

On a positive note, the pullback in the Nasdaq actually looks really constructive — it had gotten ahead of itself — and some commodities like gold had stunning mid-day rises and finished at their highs of the day. In fact USU was going to be on tomorrow's list, but instead it broke out in the last half hour. As for LVLT, I'm carrying it over to tomorrow, but the aggressive entry is no longer valid, and the aggressive exit was violated. We came within a couple points of entering on the aggressive position and then getting swept away — telling me it's not time to be aggressive. The other signal for tomorrow is STEC, which has a really nice setup, but again I caution you not to risk too much on the aggressive figures. While the market could go either way at this point, from a longer-term point of view you have to give the edge to the major trend, which is the direction of the 200-day moving average — and for the general market that direction is down. Of course the 2 trade ideas for tomorrow have neutral or better major trends — no accident there.

Ticker	Entry	Exit A	Exit C	Chart
LVLT (Level 3)	3.43	N/A	3.07	Chart
STEC	11.21	10.88	10.34	Chart

Please refer to "How To Trade This System" (right-hand side) to read this table.

Trade Idea for 8/19/08

Major rotting today in the market.

However, there's a chance that this will set us up for a rally tomorrow - after all, today's action did not produce a lower low, let alone a close at a lower low.

Today's prospect TRN sank with the rest of the market, and I don't really like the setup as much anymore so I'm not carrying it over. Sometimes though it's precisely the sub-optimal setups that end up paying off. Therefore I will only lightly discourage you from putting TRN on your list for tomorrow. Like most stocks, it pulled back far today but didn't make a lower low (I'd've scratch it outright if it had).

My trade prospect for tomorrow is a stock I already own. I bought LVLT at 3.41 on a prior setup (those of you on Zecco community already know this if you checked my profile). Because I do not allow myself to add to a losing position, I cannot buy at the Entry A price. Oh, by the way, for tomorrow's pick I decided to add an Aggressive vs. Conservative entry point. Feel to free to mix and match the A & C entries and exits, make two orders instead of one, etc. I don't think now is the time to go aggressive in general so my recommendation is not to commit too much to the Aggressive figures if you plan to use them.

Ticker	Entry A	Exit A	Entry C	Exit C	Chart
LVLT (Level 3)	3.36	3.23	3.43	3.07	Chart

Please refer to "How To Trade This System" (right-hand side) to read this table.

How Many Shares to Buy

Van Tharp has stated that the number of shares you purchase for a given trade (what he calls Position Sizing) is responsible for 90% of the performance variation of professional traders. To figure the proper position size, there are a couple of methods I recommend, both of which are covered in Tharp's book, Trade Your Way to Financial Freedom. Both methods take into account the size of your trading portfolio.

The easiest method is based on how many positions you would like to own. For example, if you have a $100,000 portfolio and would like to own a maximum of 10 positions, simply buy $10,000 worth of any stock. This is an OK method; it's better than choosing a number at random, but the second method is preferable.

Under this method, the position size is determined by the percentage of your portfolio you'd like to risk on a particular position. This number may vary depending on whether you choose to trade the Aggressive or Conservative concept. For Aggressive setups I personally risk between 0.20-0.50% per position; for Conservative setups it's 0.50-0.80%. Whichever percentage you choose, multiply it by the size of your portfolio, then divide that number by the difference between the entry and exit price. For example, using TRN from 8/18/08, risking 0.80% on the Conservative setup in a $100,000 portfolio, I get 209 shares.

Ticker	Entry	Exit A	Exit C	Chart
TRN (Trinity)	37.31	35.34	33.49	Chart

($100K * 0.80% = $800 / [37.31 - 33.49] = 209 shares.)

A calculator is located on the right-hand side of the blog.

Trade Idea for 8/18/08

Ticker	Entry	Exit A	Exit C	Chart
TRN (Trinity)	37.31	35.34	33.49	Chart

Please refer to "How To Trade My System" (right-hand side).