Mar 302012
 

The following describes how to buy extended stocks while staying within most of the key risk parameters set out by WON and CAN SLIM. I’m not recommending this, especially at this time, but I want share how to do it properly if a person cannot resist chasing a stock they missed.

An 8% stop-loss is a very unique tool that only applies at one specific place, a valid buy-point. Applying an 8% stop-loss any other time is overly restrictive and will inevitably lead to getting shaken out during normal and healthy stock movements. So if we must buy an extended stock, we need to adjust the 8% rule to accommodate the level we bought at to prevent an unnecessary shakeout. But at the same time, we also need to manage our risk and not expose ourselves to more losses than we would have had if we bought at the proper buy point.

The reason the 8% stop-loss works is because most successful breakouts will not retreat more than 4% below their proper buy-point. So with a hypothetical $100 pivot, almost all leading stocks will not dip below $96 dollars. And if you bought within the 5% buy region, or up to $105, you will be able to withstand a pullback to 4% under the pivot.

But if you instead buy 10% past the pivot, the 8% stop-loss is far more likely to get you shaken out during an ordinary pullback and you would be forced to sell at $102, far above the $96 level identified by WON and CAN SLIM as the intended shakeout protection and stop-loss level.

So if we want to use the same $96 level for a stop-loss on our $110 purchase, we now need to use a 14% stop-loss to have the same level of shakeout protection.

Since our adjusted stop-loss is nearly 2x as large as the standard stop-loss, we will then adjust our exposure by cutting our position size in half. Of course our upside is not nearly as great with half a position, but it does let us get in a stock we missed without affecting the risk of getting shaken out or increasing the potential loss to our portfolio.

If things work well in the stock, then you increase to a full position at a more traditional add-on point.

Always try to buy at traditional buy-points, but if you must chase, make sure to adjust your stop-loss and position size in order to maintain the same risk profile as laid out in CAN SLIM.

I hope this helps.

 Posted by at 12:54 pm on March 30, 2012
Mar 292012
 

The market rebounded nicely and recovered almost all of its losses from earlier in the day.  Many leading stocks also showed similar resilience and refrained from turning into a cascade of panicked selling.  In fact, much of this recent pullback has been far more controlled and orderly than anything we have seen in quite a while.

So now we need to figure  out what this means and how it affects where we are headed.  Is this stability a bullish sign that people are not rushing for the exits and supporting the market?  Or does it further reinforce the complacency argument and shows people are no longer afraid of a pullback?

By itself, this could go either way since on the surface it seems as bullish as it is bearish.  But when we start bringing in other factors, such as 14-weeks above the 50dma and the best first quarter in fourteen-years, it really starts to look like we have come a long way and the market often rests after such moves.  Also, the start of a new quarter often ushers in a new mindset among professional money managers who spent all of last quarter chasing a runaway market.  The aforementioned factors seem to tip the balance in favor of the bear camp, and if this is the case, any strength should be used as a selling opportunity.

Getting back to the prior discussion of nervous selling versus real selling, does the recent sell-off feel like nervous selling?  And if it isn’t nervous selling, then by default doesn’t that make it real selling?  And real selling is what we need to be most wary of.

And as always, I reserve the right to be 100% wrong on this.  The stock market is far from an exact science and anyone who claims to have a crystal ball is both a liar and a fool.  The market is largely random noise and it could go either way on any given day.  But by trying to understand the inner workings of the market and what drives its participants, the more it pushes the odds in your favor.  Any individual market call is largely luck, but the better you understand the market, the luckier you’ll tend to be.

Stay safe.

 Posted by at 3:00 pm on March 29, 2012

Follow up

 Intraday Analysis  Comments Off
Mar 292012
 

An important follow up on yesterday’s post, when I said “now is not the time to rush for the exits”, I’m not telling people to continue holding. If your plan calls for selling, then you need to sell. But what I was trying to convey is don’t rush into an emotional decision regarding your positions that contradicts your plan. Continue following the plan you set out for yourself.

As for a bounce, there is no grantee this next bounce will make a new high, so don’t hold out for that. And if you do sell, keep a close eye on the markets and watch how your favorite stocks hold up. Chances are the next sell-off will only last several weeks before finding support. That is the point when you want to start buying back into leading names showing the greatest potential.

And of course this recent price action doesn’t guarantee a larger sell-off. (there are no guarantees in the market) We’ve bounced many times before, so this could very well be another one of those times. If you sell, keep an eye out for strength and be ready to buy back in if the market holds up. But if this is the case, continue to stay on high alert because each successive bounce brings us closer to the one that doesn’t resume higher.

 Posted by at 2:09 pm on March 29, 2012

Rough morning

 Intraday Analysis  Comments Off
Mar 282012
 

S&P500 showing a very modest selloff.

The indexes opened the flat, but slid modestly as the day went along, losing about 1% by the afternoon.  But many of the leading, high-beta, small-cap names are faring far worse and seeing losses many times that.  This is far from the first time we’ve seen this phenomena recently, but we always managed to bounce back after those previous sell-offs.  So the question hanging in the air is this also going to bounce right back or is this the start of something more?

As I shared in my March 13th post, early in a move, sell-offs are more likely to be head fakes driven by nervous holders and premature bears, but the further along we get into this, the dynamic shifts as we have fewer nervous holders running for the exits and a greater portion of the sell-off is driven by real selling.

There is no reason to expect we won’t see a  bounce this time too, but like with a rubber ball, each bounce is often weaker than the one before it.  This is because we are shifting form nervous selling to real selling.  Nervous selling bounces like an elastic anti-gravity ball, real selling bounces like a brick. No doubt we’ll see what is left of the buy the dip crowd come in and support these discounted prices, but with every dip, that group grows smaller and weaker and the probability of a greater decline increases.  If we do bounce again, that might be a good opportunity to look at locking in some profits and waiting for the next good trading opportunity.  Remember, this is about balancing risk and reward.  Having come this far, the additional upside is more limited as compared to the air beneath us.    But this only applies to the traders out there.  Any home run hitters need to fasten their seat belt and mentally prepare themselves for some near term declines.

From a personal sense of well being, the trader who sold out when the getting was good and left some profits on the table is in a much more comfortable position as he is looking at the market for new buying opportunities.  Contrast this with the defensive trader who is nervously trying to decide if he should hold or sell.  Trading the markets is a head game and often the offensive trader has a psychological edge on the defensive trader in situations like these.  And perhaps this is why most of the great traders in history all claim they sell too early instead of waiting for the sell-off.

But this really gets back to the trading strategy that best fits a person’s personality, trading style, and understanding of the markets.  Each of us as an individual needs to decide what works best for us and then stick to that.  I’m sharing these ideas to show there are alternative ways to approaching the markets and I hope it is providing some incremental value to people.

And one last point, now is not the time for people to rush for the exits.  If you plan was to hold through a pullback, then stick to your plan.  There are two ways to do really well at this, the first is selling into strength, the second is finding great stocks and hold the dips.  The one that gets most inexperienced traders in trouble is holding through strength and then selling the dips.

Stay safe.

 Posted by at 1:04 pm on March 28, 2012
Mar 272012
 

For the last few months we had countless pundits call for a pullback in the markets, yet the indices have continued to head higher in the face of this cynicism.  As I have pointed out earlier, it is this very cynicism that provided the fuel for a sustained move higher.  But that was then and this is now, so where do we stand today?

All good things come to an end and our current rally will be no exception, so the question is if the markets are ready to rest and refresh after one of the strongest first quarters in more than a decade?

I don’t have any quantitative data to back this up, but it sure feels like far fewer talking heads are claiming we are on the verge of a pullback.  The strong surge higher has humbled anyone who tried to stand in its way and the cynics are giving up after taking more than their fair share of lumps.  And for the individual investors, it seems like the small sample of other traders I’ve talked with are very excited about their portfolio and think selling and locking in profits at these levels is crazy because there is more upside left in this move.  Both of these are highly subjective measures, but it does hint that market participants are getting as bullish as they have been in a long time.

5-year chart of the CBOE Volatility Index

One way we can quantify this complacency is by the unusually low VIX, resting near 5-year lows.  The interesting thing from the chart is every time we got this low in the last 5-years, something happened to push the VIX much higher.  But countering this, we did see VIX levels far lower than this during the 2004-2007 bull market.  So like every other indicator in the markets, this one can go either way.   This might be the calm before the storm as it has been over the last several years, or it could be the start of a new market phase of low volatility and an appreciating market.  And of course this doesn’t have to be an either/or proposition.  We could very well see a bump in the VIX in the short term and then have it settle back down at these or lower levels once the anxiety passes.

But back to the complacency, how this affects the markets is all these bulls are already fully invested and are nothing more than spectators at this point.  From here it will take new money to continue pushing the markets higher.  So far a lot of that has come from former skeptics who changed their mind and started chasing the market.  But at some point we are going to run out of chasers and that is most likely when the upside move will peter out.

No doubt bad news could send us lower, but it feels like the market is no longer obsessing over headlines, so it will take something else to bring the market down and we stand a good chance of turning down on good news simply because we ran out of new buyers to push prices any higher.

There does seem to be a lot of money watching this rally from the outside, namely in the bond market, and that could easily push equities higher, but I think this is a longer term story.  Anyone still hiding out in bonds will need a bigger kick in the pants to move.  We might be seeing the start of this as bonds have been falling and stocks have been rising.  But, no doubt there is a lot more to come.

It is impossible to give a definitive answer about the timing of our next pullback, but the end of the quarter might just be that catalyst.  Currently many money managers are behind this rally and that has forced them to chase all the way into quarter’s end.  But with a new quarter, they will have more breathing room and that will allow them to shift strategy from chasing to something else.  What that something else will be is anyone’s guess, but it will probably involve more selling than we have seen so far.

Anyway, these are just my guesses on what other market participants are thinking and what that means for the market.  As always, only trade what you feel comfortable with.

 Posted by at 10:29 pm on March 27, 2012