|
|
|
|
||
Breakout! (2)For the week, the S&P 500 Index rose to 2175.03, a gain of 0.61%. Breadth was good. It appears that the Index is poised to move higher, although next week will be the key as to whether the Index will retest the breakout at the 2135 level or keep right on going. Next week, there will be many earnings reports, a lot of economic data, and news from Japanese authorities about what stimulus, if any, will be used to jump-start the Japanese economy. If anything disappoints, then we could see a retest. If the retest is successful (which I expect), then the Index should take out 2200 in short order. I recently put together a "Trading Rules" memo for my children so that they could make money in the stock market after I'm gone, hopefully avoiding some of the pitfalls that I fell into in my 23 years of investing in individual stocks. It occurred to me that some board members might be interested in this, so here goes: TRADING RULES 1. Recognize and accept the fact that many of your stock trades will lose money. The best traders of all time are right only about 60% of the time. Many traders are only right less than 50% of the time, but still make money by having a great loss discipline. The key to making money is to exit your losing trades as soon as possible and to let your winners run. Therefore, in order to make money consistently, you must have a set of sell rules and buy rules, with the sell rules being the most important. 2. The most important general sell rule is to sell a stock immediately if it drops more than 10% below your purchase price. (Don’t enter a 10% stop-loss order on your stock; rather have a mental stop loss so that a good stock won’t inadvertently be sold if there is a flash crash in the market.) If you have a nice profit in a stock, it would also be wrong to sell too soon. Wait until a stock goes on a parabolic run (i.e. its weekly level of ascent suddenly accelerates) or drops below its 50 day moving average (“DMA”) on a daily price chart and can't recover in a week. If you're unsure of what to do about a stock, remember that you can always sell half of your position. As you reduce your exposure, your objectivity will improve on what to do with the stock. 3. Remember that prices often move down before a company’s business starts to deteriorate. If a stock's chart shows a breakdown below the 50 DMA for more than a week or the stock violates the 10% loss rule, don't continue to hold a stock because you like the company's business or think that the stock will recover unless you have some special knowledge about the company or a special event is coming in the near future. Also, you shouldn’t have more than a few of these “special situation” stocks in your portfolio at any one time. 4. Every trader has periods when nothing goes right. If you're down more than 10% for the month, consider cutting your stock exposure by 50%. Don't double down on a losing position or execute a flurry of trades in an attempt to recoup your losses quickly. If you're down more than 15% for a month, think about whether to get out of the market altogether for several weeks or months. Review your trades and try to determine what went wrong. Then do some small trades and try to get your confidence back. 5. Don't trade too large in relation to your capital. Don't let one or two trades have the potential to wipe you out. Another way of stating this rule is to be diversified. For example, if you hold 30 stocks in your portfolio and one of them has a bad earnings report and suddenly loses 20% before you can sell it, which happens from time to time, your portfolio will be down less than 1% while you figure out what to do about the blown stock. 6. Now for some buy rules. First, when you're getting back into the market after being in cash during a recession (see tip #9), pyramid in. If you're nervous, buy 20% of your position as your first buy. If you make money, follow up the first buy with another 30% buy after a few days. If that makes money, make the final 50% buy after a few more days. On the other hand, if you're more confident that a turn is at hand, you might buy 30%, then 50%, and then 20%. Never pyramid down on a losing position. Another way to pyramid if you don’t have a lot of money is to buy a full position in each stock, but buy stocks constituting 20/30/50 or 30/50/20 of your entire portfolio, assuming you were 100% in cash during the recession. 7. When looking for stocks to buy, determine which sectors in the market are the strongest (or should become stronger in relation to the current business cycle) (see tip #8) and then look at the stocks that are making new highs in those sectors. (The IBD Weekly newspaper divides the market into 33 sectors and ranks them from strongest to weakest. Try to buy stocks that are in the top ten sectors with a composite score of 90 or higher and an Accumulation ranking of B or higher.) Also pundits say “to buy on the dip;” but that's not the way the best traders buy stocks. The proper buy point should be just above congestion in a base on a daily price chart so that there is little or no resistance above your purchase price. In short, buy stocks making new highs, not stocks coming off their lows, in the strongest sectors. 8. The business cycle generally consists of four phases: the early cycle, mid cycle, late cycle, and recession. During the early cycle after a recession, the Federal Reserve Bank (the “Fed”) is lowering interest rates, consumer credit growth is picking up, and inflation is low. The best sectors to own are sectors that benefit from lower interest rates, such as, financials, consumer discretionary (including homebuilders, building supplies companies, and car or auto parts manufacturers), transports, consumer technology, and packaging companies. During the mid-cycle phase, the Fed is neutral, credit growth is growing, and business activity is strong. The best sectors to own are industrials and business software companies. During the late-cycle phase, the Fed is beginning to raise interest rates, profit margins have peaked, and inflation is rising. The best sectors to own are materials, consumer staples, health care, and energy. During a recession, business activity plunges. It’s best not to own stocks during a recession; but if you want some dividend income and are prepared to hold stocks until the economy starts recovering, the best sectors are utilities and consumer staples. 9. It’s best to stay in cash during a recession because nearly all stocks fall in value. You can tell a recession is coming if: (1) the yield curve (difference between interest rates on 2 yr and 10 yr Treasuries) inverts (i.e. yields on 2yr are higher than 10yr Treasuries), (2) price of crude oil spikes ( goes up more than 100% during a year), weekly unemployment claims top 300,000 and are rising, Conference Board monthly leading economic indicators (“LEIs”) and ECRI weekly LEIs are in a 2-3 month negative trend, CPI is rising, and/or the Fed has already raised interest rates several times. (The Fed often raises rates to cool an over-heated economy, thereby forcing the economy into a recession. Then after 6 to 9 months, the Fed starts lowering rates to create a recovery. In order to make money in the market, you must always be in sync with the current Fed monetary policy which largely dictates which phase of the business cycle the economy is currently in.) 10. If you want to sell a stock, it’s generally best to sell during certain periods of the day when volume is the greatest; i.e. during the 30 minutes after the open, around 11am to 12am (straddling the European stock market close) and the 30 minutes before the close. If you want to buy a stock, it’s generally best to buy around 10am, especially during bull markets when the market often moves lower between 9:45 and 10:15am and then rises throughout the day. (You might want to review the intraday trading history of the stock you want to buy or sell the day before you want to make your trade to determine what periods during the day the stock traded lower or higher, as the case may be.) Always use limit orders. For example, if you want to substitute one stock for another, you might watch the stock you want to sell during the morning and place a limit sell order a little above the current price, figuring the stock will go higher by the close. Then you would buy the replacement stock the next morning, placing a limit buy order which is slightly below the price of the stock a few minutes after the open, figuring that it will dip at some time during the next hour. It takes some experience to get the best intraday prices for your trades. You will get better at trading over time. 11. Now for a few general observations. Don’t pay any attention to what the pundits are saying about a stock. If you are managing your family’s or other people's money, don’t let their greed or fear influence your trading. Listen only to what the price and volume action on a chart is telling you about your stock. Don't have any preconceptions about your stocks. Be flexible. 12. Don't buy stocks that are over-extended (i.e. more than 10% above the stock's last base on its chart) or stocks with a price earnings (PE) ratio of more than 2x the S&P 500 average PE. Don’t be tempted to chase the stock of a great company if the price isn’t right. Also, don’t buy stocks that are less than $10/share or have a daily volume of less than 300,000 shares. There are plenty of other fish in the sea. 13. At the end of each quarter, take a look at your portfolio. Are there any laggards that should be sold? Are there better opportunities in other sectors? Or, on the other hand, are you doing too much trading, churning your portfolio with no real advancement? Also do a postmortem on each of your trades. What percentage of your trades during the quarter were winners? Did you follow the Golden Rule of stock investing (i.e. cut your losses below 10% per trade and let your winners run) for most of your trades? If you don't take the time to analyze what went right or wrong, then you likely will continue to make the same trading mistakes. In the stock market, you can't consistently make money be being "lucky;" you must have trading rules and you must follow them without exception. Everybody's trading rules will be different depending on what that trader is trying to do. Hopefully, some of my trading rules will help you. GLTA! Savannah |
return to message board, top of board |
Msg # | Subject | Author | Recs | Date Posted |
20663 | Re: Breakout! (2) | Dannett | 1 | 7/25/2016 8:13:25 PM |