Latest Stock Market Investing Articles

Control Risk and Loss in the Stock Market

Sat, 25 Jul 2009 08:01:19 -0700

Risk is the probability of loss. It is best to estimate it and to adjust your purchase and sell strategies to it in order to control loss before the purchase is made. Correct timing of purchases, buying near support, limiting loss potential, and stopping the decline by using volatility stop losses are all ingredients of a good risk control system. Let's look at a few of these loss control discipline components.

One method of controlling risk is by timing purchases so that they occur at or near support. That way, your stop loss can be a very small distance away from your purchase price. If you buy when the stock is 5% above its trendline, for example, it will mean little if the stock declines 5% to reach its trendline. Since stocks often return to support, why would you sell? You would sell only if it broke to the downside through its rising trendline. Therefore, your loss would be calculated by adding the distance the sell point is below the trendline to the distance the purchase price was above the trendline. Buying at the trendline instead of above it would eliminate that unnecessary 5% loss.

However, stocks often make a small temporary penetration through a support line and then resume their climb. When, precisely do you sell? Let us use the suggestions offered in Technical Analysis of Stock Trends by Edwards and Magee as an example. If you are using stops that are based on closing prices, they suggest a trendline penetration of 3% would warrant selling. If your stop loss is placed with a broker, they recommend that the stop be placed 6% below the trendline because of the possibility of inconsequential intra-day spikes. Therefore, if you buy when the stock is 8% above its rising trendline and place the stop loss 3% below the trendline, you will lose 11% before your stop is triggered. On the other hand, if you wait for the stock to return to its trendline before buying, you will lose only 3% if your stop is triggered. It is important to buy right so that you can sell right.

Risk is also blunted when the downside behavior of stocks is strictly limited to predefined tolerances. For example, a stockdisciplines.com trader (NT) might plan his purchases so that the projected profit is about three times the expected loss if the trade goes against him. Thus, in order to try to capture a gain of 6%, the stop loss must be no more than 2% below the purchase price. If he can reasonably expect a gain of 12%, then his stop loss would be no more than about 4% below the purchase price. Long-term investors can use a ratio perhaps as low as two to one because they have a presumptive tolerance for wider price swings and a longer time-horizon. It can take more than one price cycle to reach the targeted profit, and the uncertainty associated with the accomplishment of that is already part of the risk accepted by the long-term investor. Therefore, there is greater tolerance for negative price movement relative to the expected gain. The trader, on the other hand, does not have that luxury. He must put into effect more rigorous profit to loss ratio requirements.

Another approach to blunting the downside behavior of stocks is to reject as a purchase candidate any stock that has a logical stop loss placement greater than a certain amount. Let's say that our investor or trader finds a stock with a great story and feels he must have it. The stock is climbing rapidly and it looks as though it will never be at the current price level again. If the stock is rising at a steep angle of ascent, an appropriate stop loss may be 16% below support. If his rule is never to risk more than a 1% portfolio loss because of a single position and he has 15 positions, the stock must be rejected. A 15% loss on one position when there are 15 positions would cause the portfolio to lose 1%. A 16% loss would exceed the limit. Though downside behavior would be permitted within the parameters and tolerances of the prevailing growth pattern, the outer limit is set at some specific amount by design. The amount should be determined by the overall risk assumed by the portfolio. For example, limiting the portfolio's risk to 1% per position would mean that a portfolio of 10 stocks would have to reject any stock that has a logical stop loss more than 10% below the purchase price.

The volatility-adjusted stop loss makes use of probability theory. The idea here is to measure the stock volatility and place the stop loss just beyond the normal price excursion of the stock. The distance of the stop will be determined by the investor's preference as to the probability that the stop loss will be triggered by the random non-meaningful fluctuations of the stock. Thus, he can set the stop so that it will be triggered once in twenty days, once in 100 days, or once in 200 days because of a random surge. Any probability can be chosen. Let’s assume that our trader wants to minimize the chances that a random spike will trigger the stop. He could set the stop so that a random spike would be likely to trigger the stop no more than once out of 161 days by setting the stop 2.5 standard deviations below the average price. Other probabilities are reported in the twenty-fourth stockdisciplines tutorial. These statistical references may sound complicated, but there is a tool available to traders that makes it possible to do this without any knowledge of statistics. Since random noise in the stock's behavior would cause a sale only once in 161 days, then the probability is quite high that if the stop loss is triggered, it is because the stock is misbehaving to a significant degree. An unusual decline has occurred, a decline that is well beyond what is probable for that stock. Think about it. Those are precisely the conditions under which an investor would want to sell. The beauty of this approach is that the stock tells on itself. It's as if the stock were shouting "hey, I’m behaving badly. Sell me before I cause you pain!"

One characteristic that differentiates an expert trader from an amateur, is that all the losses of the expert are small. He has no large losses. The trading pattern of amateurs is strewn with losses and gains of all sizes. Amateurs and experts can both find big winners, but amateurs are likely to lose those gains on subsequent trades. Only experts consistently control their losses so that none of them are large. If you learn to control risk (limit the downside behavior of stocks), accumulated profits should be the consequence. In the market, it is wiser to concentrate on developing a good sell strategy than to concentrate on developing a good way to find winning stocks. Part of controlling risk is buying right. Any stock can be a winner if it is bought right. The bottom line is that it is more a matter of what you can keep than what you can gain. If you want to perform like an expert, develop your stop loss and selling disciplines. Many professional money managers do not have true ownership of this principle. It is imperative that you make loss-control an integral part of your discipline.

The increased volatility of the market caused me to review my data on thousands of different strategies. I saw the elements that all the most profitable strategies had in common. The point was driven home. All these strategies exercised rigorous risk control. Sometimes they even generated more losses than gains, but they were all profitable. There was one characteristic trading pattern all the strategies had in common. They all generated consistently small losses and occasional big gains, but they never had a large gain wiped out by a large loss. There were no large losses.

Copyright 2009, by Stock Disciplines, LLC. a.k.a. StockDisciplines.com

Where to Put a Stop Loss

Sat, 25 Jul 2009 07:46:06 -0700

It is virtually a "law" of trading in the stock market that wherever you place your stop loss, it will occasionally be triggered by a stock just before it resumes its climb to higher levels. That is just something to be expected if you use any stop-loss. Unfortunately, not using a stop-loss is asking for trouble of a much greater magnitude, and the market loves to reward the foolish, lazy, or stupid, with the just recompense of their behavior. It makes no difference if you set the stop at 10% or at 3% from the low, high, or close. You can use stops that are volatility-based, use Fibonacci retracement ratios, Gann analysis, pivot points, percentage declines, or any other approach. No matter how sophisticated your mathematics is, you will often find you have sold for no good reason other than the occurrence of a temporary price spike that was just sufficient to trigger a stop loss -- your stop loss. Learn to live with it

On the other hand, you can control risk and have some say about the probable frequency with which you will be ejected from a position because of such a spike. The further your stop is from recent price action, the less likely it is that it will be triggered. However, the further your stop is from the price action, the more risk (downside price excursion) you are going to have to tolerate. Not using a stop at all means you are willing to accept unlimited risk. Using a "tight" stop means you are willing to tolerate very little risk but you dramatically increase the chances that even a minor spike will eject you from the position. The tighter your stop, the more ejection-causing spikes will occur in any given time period. The only way to resolve this dilemma is to find the best tradeoff between an acceptable frequency of unnecessary ejections and an acceptable amount of loss that you incur because of that ejection. In other words, you must find the compromise that induces the least amount of pain (psychological or financial).

Magee and Edwards (Technical Analysis of Stock Trends) teach that a good stop based on closing prices is one that is placed 3% below a rising trendline. The stop is triggered only if the stock closes at or below the stop. However, if a trader intends to sell on the basis of intra-day price activity rather than on the basis of closing prices, they suggest that the stop be placed 6% below the rising trendline. Below the trendline or below the most recent minor dip is usually the best place for a stop. However, sometimes there is no trendline or obvious recent minor dip. That is when you must use a mathematical stop. Either a simple percentage based on the highest high, low, or close since you purchased, or a volatility-adjusted variable stop placed relative to the highest high, low, or close since you purchased will serve the purpose. Magee and Edwards, Weinstein, Schwager, Murphy, and many others use trendlines, dips, or moving averages as a reference for placing a stop. Rising trendlines follow the lows, dips are nothing more than significant recent lows, and moving averages generally follow a rising stock somewhat below its recent lows. Therefore, it also makes sense, in the absence of all of these, to use the recent highest low as a reference for placing stops. With no trendline or dip to use as a reference, you could simply place your trailing stop 3% or 6% (or some other distance) below a moving average that closely follows the trends of significance to you, or even below the highest low achieved by the stock since your purchase.

The anticipated average holding period has a very big impact on how tight your stops are going to be. For example, the "sweet spot" for the 2.3% rule is about 10 to 15 market days. The short end of the "swing-trader" spectrum is about 3 days or less (a large number of traders focus on holding periods of up to about one week) and the long end of the spectrum is 8 to perhaps 10 weeks. The remaining swing traders focus on the time frames in between. At the very short end, the 2.3% rule allows too much of a decline relative to the expected gain. However, it works well when you are trying to lock in a two-week move involving a 4% to 10% gain. If the stock is not too "wild," it will also work beautifully for moves of a month or more to lock in gains of 10% to 20% or even more. However, you may have to loosen the stop a little for more volatile stocks and for regular holding periods of more than 15 days. For longer-term investing, for example, a stop that is up to 6% below the highest low reached by the stock since it was purchased can be very effective. A stop that one stockdisciplines.com trader (NT) experimented with and found to be very useful for intermediate-term trading is one that is set 4% below the highest low. In use, it was infrequently triggered by a whipsaw and it did not give up much of the gain of the bigger moves. However, it would also give up 4% or more of the smaller 8% moves. That is why some traders focus on stops of 3% or less below the highest low. The tradeoff was the greater frequency with which a person is needlessly stopped out of a rising stock. It would be best if you worked out a personal stop-loss system, one with which you can be comfortable.

If you want a reference point other than the highest low, the following may be of help. A test of all the stocks in The Valuator showed that the average low was 1.7466% below the average high and .882% below the average close. This information can be used to place the stop relative to the highest high or highest close of the stock since its purchase. Thus, if the stock spikes up, the stop will lock in more of the gain. This works best when the stock makes a series of new highs, each significantly higher than the previous one. However, a 1-day spike may cause you to be stopped out the following day if the stock quickly returns to more "normal" levels. Walk away from stocks that often spike down. The specialist may simply like to "gun" the stock in order to take out the stop-loss orders waiting at the lower prices. That is, the specialist temporarily drops the stock price to trigger the sell orders associated with the stops so he can buy those shares at the lower price and sell almost immediately afterwards at a slightly higher price. When considering the purchase of a stock that often spikes down, the trader should try to place the stop just outside the specialist's spiking comfort zone. If such a placement requires the assumption of too much risk, find another stock. I prefer to concentrate on stocks that rarely spike. Look at charts and notice the length and frequency of downward spikes. Try to determine the percentage drop these spikes represent.

A volatility-adjusted stop has a more universal application than a simple percentage stop because in addition to adjusting for volatility it also adapts to the time period of the particular "analysis unit" used (15-minute price bars, 30-minute price bars, daily price bars, and so on). Rigid percentages cannot do either, but they are easier for the non-mathematician to calculate. If you are trying to compute your own stop-losses and you do not have a mathematical background, you might do well to use a stop loss calculating tool (do a Google search on "stop loss tool" and follow the trail) or simply make appropriate modifications to the 2.3% rule. That is, if your stops are triggered too frequently before upward moves complete when you follow the 2.3% rule, change it to a 3%, 4%, or whatever. However, we believe the volatility-adjusted stop loss is not only more sophisticated but also more effective. Now, consider the following.

The stop is not necessarily your sell discipline. However, it is definitely your safety net. It will preserve assets if you are not paying attention to your stock's behavior during the day. If you do not have time to be riveted to the etchings the stock market makes across your computer's screen, you only need to take about 10 minutes to go through your positions once a day (even while the market is closed) or once a week (even on weekends) to set your stops. Then you can ignore the market until you make your next stop adjustments. However, if you happen to be watching your stock and it does not "behave" like it should, simply remove the stop and sell the stock.

Copyright 2009, by Stock Disciplines, LLC. a.k.a. StockDisciplines.com

Select Stocks by Combining Technical and Fundamental Screens

Mon, 29 Jun 2009 18:42:48 -0700

Short-term traders tend to concentrate on technical chart patterns, and long-term investors tend to pay much more attention to the fundamentals of the company. However, both types of market participant should use a combination of the two approaches for better timing and greater returns. The technical setup pattern can give some assurance that an upward move is likely soon. One or more good fundamental measurements can give some assurance that if the stock does start to rise to a higher price, its ascent is likely to be a trend of significance.

Before we look at the stock selection method, a brief note about the relative merits of fundamental and technical analysis might enhance the understanding of some readers. Fundamental considerations are most important for long-term holders of a stock. A stock may gain 10% or more over a one-year period. That move will likely be driven by the fundamentals of the company. However, as holding periods shorten, there tends to be more randomness (noise) in stock behavior. The short-term forces at work in the environment (wars breaking out abroad, indictments, terrorist threats, Fed meetings and decisions, etc.) cause investors to be concerned about one thing and then another. That is, stock behavior becomes less dependent on fundamentals and more dependent on short-term shifts and trends in investor psychology and mood. Hence, on the way to making a return of 10% for the year, a stock may go through several cycles in which it swings up and down 15% or more.

Announcements of a fundamental nature (earnings sales, return on equity, product development, and so on) can cause a stock to spike up or down. The fundamentals can also cause a stock's price pattern to have an upward bias. However, fundamentals generally have less influence on the short-term behavior of stocks than they do on long-term trends. That is why technical analysis is so important in volatile markets. Technical indicators are extremely useful in the timing and analysis of short-term as well as long-term turning points and in estimating the probability of trend endurance. Fundamental analysis is more useful for long-term thinking and valuation considerations. Fundamentals give investors the psychological endurance necessary to hold a position long-term through numerous gyrations. However, the way the market weights and values the fundamentals of a company can change, even if the fundamentals remain unchanged. Such changes can make it unwise to continue holding a security that moves outside the "probability envelope" of its behavior pattern. Nevertheless, even in a volatile market where a position is likely to be held less than 4 months, it is better to invest in a stock supported by good fundamentals than in one that is not. The good fundamentals should give a stock a positive long-term bias, and this may very well enhance the short-term behavior of the stock. When fundaments are sparse, doubtful, or unavailable, traders may use the long-term trend of the stock as a context for the short-term and intermediate-term behavior of the stock.

The stock selection methodology illustrated here could be implemented by using Daily Graphs or The Value Line as a valuation reference. We consider The Value Line to be the best of these for our purpose because we like to use estimates based on the last 6 months combined with earnings estimates for the next 6 months. We believe such estimates are far more accurate than those that look ahead a full year, and that they are more relevant than those based on last year's results. Value line does provide data based on approximately 6 months past and estimates for 6 months future, but you must put the data together and compute the ratios. For that reason, we prefer to use The Valuator. It combines data from approximately the last 6 months with analyst projections for the next 6 months to derive its valuation measurements, including its PE and PEG ratios. For the purpose of implementing this strategy, it is a far more efficient tool than either Daily Graphs or Value Line, but you should use the reference that works best for you (do a Google search on any of these for more information). Use any publication that works well for you. In implementing the strategy, I prefer to see at least one value measurement that looks good. For example, when reviewing the lists generated in The Valuator (these are lists of stocks ranked in the top 10% for each valuation measurement), I usually find a number of interesting candidates that then need to be screened for their technical attractiveness. For example, our stockdisciplines.com NT traders scan the chart patterns of the more than 40 stocks with the lowest PE ratio listed in The Valuator. They use the list of stocks that are most depressed below their historical fair value, the stocks with the lowest PE ratio, the stocks with the lowest PEG ratio, and the stocks that have the highest ranked composite valuation (a measurement that combines several other measurements). All of these measurements are based on one-year data that combines approximately the last 6 months actually achieved with analyst estimates for about 6 months ahead.

They scan the charts of these stocks looking for technical patterns known as "setups" because these configurations usually precede a continuation of upside price movement. They include breakaway gaps, ascending triangle patterns with an upside breakout, declining flag patterns with an upside breakout, Bollinger Band squeezes with an upper band penetration, a "bounce" off of a rapidly rising 50-day moving average, and so on. They look for volume surges with any of these setup patterns.

The technical pattern is very useful in the timing of purchases and sales. If the fundamentals are good but the technical pattern is not attractive, the stock is not purchased. Though the stock may be a great purchase from a valuation point of view, it is not from a timing point of view. We do not want to waste time in great stocks that are not on the move. On other occasions the pattern may be attractive, but we will not buy unless the fundamentals have something positive to offer. Let me illustrate the reasoning behind the decision process by the use of an example. At one time I wanted to buy Apple because the technical configuration of the chart looked very good. It had formed what is known as a "cup without a handle" and it broke out above the rim of the "cup" on 8/12/05 with heavy volume. Then it had the normal profit-taking sell-off (with declining volume) that follows such moves. It fell back to support at 45 (which held and then drove the stock upward again). That is when I bought. The bounce off of support was my trigger signal. However, because of the industry it was in, I was determined not to buy unless there was some fundamental reason (other than the technical reason described above) that it could sustain an upward trend. The Valuator showed that it could rise 18.7% before it would reach its historical fair value. That is, based on how the market has valued the financials (earnings, etc) of the company in the past, and based on current 6-month forward analyst estimates, the stock could rise 18.7% before reaching what the market considered to be its "fair value." Also, The Valuator displayed a star showing that the stock was rising faster than fifty percent of all rising stocks. Most of the other valuation models in our reference gave a poor showing for Apple, and its overall valuation ranking was only in the 41st percentile. However, the PE-ratio relative to the company's projected 3 to 5 year earnings growth rate gave a PEG ratio of only .6. A reading of 1.0 usually means "fairly priced," but 1.5 is perhaps a more appropriate "fairly priced" reading for technology companies. A reading of .6 suggested that Apple was a bargain relative to its earnings growth rate. All I wanted was one good fundamental reading to justify a purchase. Apple gave me two, so I bought it. The stock subsequently climbed from a closing price of $46.89 on 8/31/05 to a closing price of $85.58 on 1/13/06.

It had a combination of both a good technical setup and two attractive metrics of a fundamental nature. The technical pattern showed only that the timing was right for a purchase. Short-term traders tend to buy a stock that has a good setup and that has begun to move from that setup as anticipated. This creates a momentum surge that attracts others. Investors of a fundamental persuasion notice the stock and invest in it because of the fundamentals. The fundamentals are what enabled the stock to sustain its "flight" to a much higher valuation. If the fundamentals were not there, the stock would likely have declined shortly after its initial surge. That would be sufficient for very short-term traders, but those who are looking for a more sustained move should include timely fundamentals in their filtering requirements.

Copyright 2009, by Stock Disciplines, LLC. a.k.a. StockDisciplines.com

Investor or Trader: What's the Bottom Line?

Mon, 15 Jun 2009 10:37:12 -0700

"Buy and hold" say the long-term investors. "Sell losers quickly to cut losses" say the short-term traders. "We are in it for the long-term" say the investors. "Hold only rising stocks, and let profits grow" say the traders. Though most people who call themselves "investors" are not really disciplined, those who are disciplined have much in common with traders.

Most investors are happy if they get a return of 7% to 10% a year. Most traders feel like a failure if they have not achieved at least a 30% return. Investors feel elated if they get 15%. Traders feel the same if they get 60%. On rare occasions an investor will get a return of 30% to 35%. Some traders get occasional returns in excess of 100%. In general, seasoned traders aim for a return that is three to four times as high as that of an experienced investor.

Many "investors" buy shares in a few mutual funds. Mutual funds tend to hold onto stocks while they rise and fall. Other "investors" buy a basket of stocks and hold them while they rise and fall. Both of these groups will, on average, obtain performance that is not too different from that of the market as a whole. On the other hand, "traders" often beat the market's performance by a wide margin because they are selective, pay attention to timing, and do not ride their stocks up and down. They are disciplined in both their buying and selling. Stocks often evidence characteristic patterns of behavior when they are setting up for a meaningful rise. Traders learn to recognize those "setup" patterns. When a stock begins to fall they sell and buy another that has completed an attractive "setup" and that has just initiated a high-volume momentum surge.

Most traders will buy a stock then follow it up with a stop-loss order placed at a calculated distance below its current price. This "stop" is raised each day as the stock rises. These traders do not have to make a separate decision about when to sell because the stock sells itself when it drops to the stop price. For them, stop-placement defines one-half of their buy/sell activity. Our stockdisciplines.com traders use both primary and a backup selling systems. The primary system is usually a well-defined and sensitive discipline that can sometimes generate a sell signal before a well-placed stop is triggered. They also use a stop loss as a backup safety net in case their discipline does not sell quickly enough. You can benefit from their experience by doing the same thing. Stop placement should define at least one-half of your sell discipline.

Let's look at the difference in attitude between most investors and most traders. Most investors will hear of a stock that has been in the news lately because of a new product, technology, discovery, or potential cure. They will say to themselves something like "XYZ Co. is a great company. Someday they will cure cancer. I should buy some of that." Then they buy it. They believe in the company and its long-term growth prospects. During the following year, the stock may fall 5%, rise 17%, fall 15%, rise 20%, fall 10%, rise 17%, fall 7%, and finish the year up 17% from the original purchase price. The investor will be pleased with his decision and with the profit he has made. If a trader hears about the same stock, he will not do anything without first looking at a chart. He will observe that the stock is declining, and will not do anything until the stock nears support or until the stock completes a setup configuration that the trader likes. Then, as momentum begins to build, he will buy and follow the stock up with a stop loss. His approach will give him a high probability of capturing a good part of each rise and of avoiding most of each decline. His total return will be much higher, and his risk will be much lower. Why do we say his risk is lower?

We say his risk is lower because there is no guarantee that any stock will recover. If it doesn't, then buying and holding is riskier than selling immediately when the stock misbehaves. For example, many investors held on to LA Gear when it began to decline, refusing to take a loss when doing so would have allowed them to recover most of their money. They assumed they could get all their money back when the stock recovered. They told themselves that to "buy-and-hold" was the smart way to invest. They might have even patted themselves on the back and proclaimed that they were long-term investors, not "twitchy traders." LA Gear's stock eventually became worthless, and the entire amount invested simply evaporated (not just the small amount of loss that investors were hoping to regain). Genentech fell over 77% from its high (even though TPA was supposed to generate annual sales in the billions and Genentech had the patent rights). Yahoo dropped from $250.06 to $8.02 (over 96%). IBM fell over 76% from its high in 1999. CMGI sold for $163.50 before it plunged to .28. Broadcom was $274.75 before it dropped to $9.52. JDS Uniphase sold for $153.42 before it declined to $1.58. Unisys sold for $48.37 in 1987 before it dropped to $1.75. Each of these stocks had a good story. Some of these stocks no longer exist. None of them are even near their previous highs, and there are many others like them. Any stock can have a similar drop. To us, riding a stock down when it is headed for oblivion is assuming a great deal of risk. These investors cling to the mantra that buying and holding is the correct way to invest because they do not have a discipline for selling, just as they have no real discipline for buying.

High performance longer-term investors (names like Zweig, Dines, Sullivan, Weinstein, Granville, Murphy, and others come to mind) are similar to traders in many respects. In a good year, these people might earn 20% or more while the market rises 10%. They all advocate the use of stop-loss orders to protect assets. The main difference between them and traders is that they have a longer time-horizon, and their stop loss orders allow a greater range of price fluctuation. Like the sophisticated traders, the most sophisticated longer-term investors use stops that are no more distant from the price action of a stock than is appropriate for its volatility and the investor's investment time-horizon. The fact that they have a longer holding period does not mean they can be sloppy with their stop placement. Their targeted gains are much smaller relative to the time invested than those of top traders. They cannot afford to take large losses. Pattern-relevant stops and Volatility-adjusted stops are just as important to top investors as they are to top traders.

Copyright 2009, by Stock Disciplines, LLC. a.k.a. StockDisciplines.com

An Intermediate-Term High-Performance System

Mon, 25 May 2009 05:30:10 -0700

A system that keeps you invested in the strongest stocks of the S&P100 Index and without any of its weak stocks should enable you to outperform the market by a wide margin. For high performance, you must use the right kind of strength measurement, regularly rank the stocks, and keep the highest-ranked stocks in your portfolio.

Consider that the market appreciates more than 10% a year on average. That is, the market has a long-term upward bias. The S&P500 is used by professional analysts and money managers as a proxy for "the market." The S&P100 is made up of the 100 largest and most important stocks in the S&P500. The S&P100 tracks the S&P500 closely but has slightly outperformed it over the years.

Thus, a portfolio consisting of all the stocks in the S&P100 is likely to rise about 10% a year on average. Half the stocks in the portfolio may be rising and half may be falling, but the rising stocks will usually have a slightly greater impact on the portfolio than the declining stocks (otherwise, the index would not rise). If we disregard the impact of weighting factors, we can make a general observation. If the declining stocks generate an average loss of 5% a year over 10 years, then the rising stocks must generate an average gain of 15% a year in order for a portfolio consisting of all the stocks in the S&P100 to gain an average of 10% a year. Similarly, if the declining stocks generate an average loss of 10% a year over 10 years, then the rising stocks must generate an average a gain of 20% a year in order for the portfolio to average a gain of 10% during the same time. Declining stocks cancel out the gains of rising stocks. If a stock rises 35%, the portfolio benefits greatly, unless it contains another stock that declines 35%. If it does, then the portfolio gains nothing. What do you think the performance of the portfolio would be if the portfolio had all the rising stocks but none of the declining stocks?

Assume that we measure the strength of each of the stocks in the S&P100, and then rank all the stocks in the order of their strength. If we were to keep a portfolio invested in the 50 strongest stocks, it should greatly outperform a portfolio invested in all 100 stocks. The weakest stocks would not be present in the portfolio to counterbalance the performance of the strongest stocks. If we were to screen the 50 strongest stocks and eliminate the weakest 20 of the 50, it is reasonable to assume that performance will be even better for the remaining 30 than for the 50. Why not focus on the top 10? Because we want to keep the turnover rate relatively low. Stocks will not stay among the top ten nearly as long as they will stay in the top 30. How can we use this idea to create a real-world high-performance portfolio?

First, we need a method of measuring strength. Second, we need to have a procedure for adding stocks to and removing stocks from the portfolio. The Relative Strength Index (RSI) is often used by technicians to measure "strength," but it is woefully inadequate for our purposes. Its "snapshot measurements" are too time-constrained to locate stocks that have what we call "persistent internal strength." Stocks with a high RSI are far more likely to be in an unattractive chart pattern context than stocks that rank high with the strength-measuring tool we use. The "Strength" model we use is far more complex. To give you an idea of what you might do yourself, stockdisciplines.com investors use a strength measurement that requires 6 algorithms for the first sort and then 3 more algorithms are applied to the results of the first sort to derive the final scores. The results of the latter are then ranked. This information should help you conceptualize the process.

Value Line and Morningstar do not use this approach, but a similar system is used in the strength rankings in The Valuator. However, if you do not have access to this kind of ranking system, you could try using the RSI over three time periods (for example, the standard 14-day measurement and two others of different longer periods) and total or average the results before ranking them. This may not work as well, but it should be far better than using only the 14-day RSI. Unlike the simple 14-day RSI, these measurements really can help a person find stocks that have a much more attractive pattern context. Of course, the universe of stocks being measured will determine the outcome. That is, the strongest stock can only be the strongest stock among those being ranked. Bear in mind that the highest ranked stocks may not be the ones that have appreciated the most in the last 14 days (the latter may have substantial overhead resistance just above current prices).

The Method

Create a high-performance diversified portfolio by ranking all the stocks in the S&P100 according to their strength. Then select the highest ranked 20 to 30 stocks for inclusion in the portfolio. Replace any stock that falls out of the top 20 to 30 list. The negative impact of the cost of buying and selling a few stocks occasionally will be minimal in such a portfolio, especially at deep discount commission rates. Also, even if a stock were to decline 20% before it is sold, its impact on the portfolio would be only 1/20 to 1/30 of 20% or about 1% or less. However, this much loss would be an unlikely event because the stock would probably have been sold while it was still among the top 40 stocks. Another strength of the discipline is that the portfolio is always invested in the 20 to 30 strongest stocks and in none of the weakest stocks. Furthermore, losses would usually be minor, having relatively little negative impact on the portfolio. Remember that the ultimate performance of a portfolio is determined by the percentage of time the portfolio is invested in rising stocks. Empty portfolio slots and declining stocks work against top performance.

Stock Market Investing: Long-Term or Short-Term

Sat, 16 May 2009 06:49:42 -0700

To have a pre-disposition to buy and hold stocks for the long-term can be an extremely expensive frame of mind. The long-term market trend is up, but in a volatile stock market, the long-term gain is often laden with risk and not nearly as great as many short-term gains. Risk vs. return has greatly increased for the long-term stock market investor. People argue that tax consequences are their reason for holding. That argument lacks weight. It is very difficult for some people to break away from old habits and patterns of thinking about the stock market. Those who are unwilling to learn from market crashes are doomed to repeat the lesson.

A few years ago, investors were told that to buy and hold for the long-term was the wise course of action for investors because the long-term trend of the market is up. If you took any other approach, you were a speculator at best and a gambler at worst. Brokers and mutual fund managers were the most vocal proponents of this investment philosophy. The media also joined the chorus and the concept became a part of the "accepted" market lore. Investor thinking, in this regard, lost elasticity. What was overlooked was that selling a stock that has entered a phase of heightened risk actually reduces portfolio risk, whether it has been held a year or not. It is important for us to have clarity about the main issues relating to the length of an investor's holding period.

The new volatility of the market is probably here to stay. The current reality of the market is that in a given year stocks will often undergo multiple price swings in which the magnitude of those short-term swings is often equal to or greater than the magnitude of its 1-year price movement. Even stocks that lose money if held for a year may be very profitable at several times during the year. Unless the long-term expected gain is much greater than the average return on stock investments, it is a high-risk gamble to retain a stock that has moved up 20% in only 2 months once its charted growth rate has started to show signs of breaking down. The probability is that holding on to such a stock to meet a 1-year long-term tax requirement will cost way too much. When stocks move up rapidly, it is common for them to vigorously and abruptly "correct" to the downside once they begin to break down. It's like a crowded auditorium in which someone yells, "fire!" Everyone wants out at once. Potential buyers then become like those outside the auditorium waiting to get in. When they see all the people rushing out in a panic, they naturally decide to wait and watch rather than entering. Thus, while the potential buyers wait, the stock plummets.

The potential reduction in the investor's tax rate resulting from a long-term holding period is not sufficient to make up for the substantial risk of loss. If you have a 20% gain, why not take it rather than lose it? Selling in less than a year is fairly easy to justify under these conditions. Though the figures can vary depending on how you file, even at the highest tax rate it would still make more sense to sell under such circumstances (tax rates may be somewhat different when you read this but the point remains the same). For example, even if your income were $500,000 a year and you had no deductions, 3 short-term gains of $18,000 or 2 of $27,000 would net you more after taxes than one long-term gain of $40,000 taxed at 15%, regardless of how you file. That is, taking several small short-term gains in a choppy market can be more profitable than hanging on to a stock in the hope of obtaining a larger long-term gain. Furthermore, in an environment where the long-term gain is unlikely to be obtained (and where the gains already achieved are likely to be siphoned off by the market), it makes even more sense to lock in the profits already obtained once a stock begins to break down.

Stocks do not move in a linear fashion. Stockdisciplines.com traders have found that if a stock is up 20% in 5 months, it is unlikely to be up 40% in 10 months. It is more likely to be up 8% in 10 months or even down 10%. Hence, the key to higher net returns is to base investment decisions not on the nature of our tax code but on the proper weighing of risk against reward. If all things were equal, it would generally be better to hold for the longer term. This is obvious, and it is our own preference. However, all things are rarely equal and stock patterns do break down. When a stock begins to drop, the preservation of capital is much more important than getting a lower tax rate. Those who invest by the tax code rather than by the signals given by the stocks themselves often end up paying less in taxes because they don’t make any money. They get the deductions they long for (a lot of losing positions) but not the profits. The priority should be to make money in the first place and after that to have your CPA help you keep it from being taxed away.

The fact is that no one can say for sure that none of the stocks in a given portfolio will plummet out of existence (even if they are all blue chips). Of course we would all like to buy nothing but steady climbers and leave them in the portfolio for a year or more to get the long-term capital gain tax benefit. Five years would be even better because it would reduce transaction costs. However, the market and your stocks do not care about your wants, needs, or tax status. Also, transaction costs can be minimal. At one well-known discount brokerage firm, for example, it is possible to sell out a position worth $50,000 for only $7. If the stock price is $40 a share, the brokerage commission for this trade would come to little more than half a penny per share. This cost is insignificant relative to the loss that could be incurred by keeping a loser.

If we buy a stock and it starts to break down shortly after we purchase it, we must admit that either we were wrong or that the unforeseen has occurred. Certain conditions and requirements had to be met by the stock and/or the company for us to buy it in the first place. If those conditions no longer exist, we must sell. Our prime consideration in a volatile environment must be to preserve assets, even if we have to sell a stock the day after we bought it. On the other hand, if we achieve a return of 20% in 6 months and the stock is still strong and still close to support, we will continue to hold because we have not been given a reason to sell. The same would be true if we had held the stock for 5 years and our gain were much greater. The stock itself, or the market, will tell us when we must sell. Volatility-adjusted stop losses are extremely useful in this regard.

There is no way to know in advance how long a given stock should be held. We should not invest on the basis of what we think ought to be but on the basis of what is. Though a 1-year minimum holding period is desirable for tax considerations, it is meaningless and arbitrary in the context of market behavior. In fact, rigidity in our thinking along these lines can be very costly. Of course we want to hold a stock as long as we can, but rate of growth and risk should not be ignored. A stock that has proven itself incapable of breaking through overhead resistance no longer has growth potential, and continuing to hold it involves risk of loss (the risk/reward ratio has changed). In fact, risk of loss will increase as others conclude the stock will not go higher.

It is difficult to leave behind old concepts of investing. It is one thing to be aware that a particular stock has given a sell signal and another to break loose from old ways of thinking in order to act on that signal. This is something that takes time to internalize to the point where it is automatic. A good, well-articulated discipline can be an effective trainer in this regard. There are, after all, lessons to be learned from every plummeting stock and every market crash. Investors must learn to allow stocks and the market to give their own signals. When those signals are given...we must learn to listen.

Copyright 2009, by Stock Disciplines, LLC. a.k.a. StockDisciplines.com

The Best Stop Loss for Long-Term Investors

Sun, 19 Apr 2009 04:48:33 -0700

There is always a chance that the stock will reverse direction just after it has triggered the stop loss, no matter where a stop loss is placed. We wanted to know if the amount of decline allowed by the stop loss affected the probability of a reversal immediately after the stock is sold. To answer this question, we computed the percentage of incidents (over a period of about 20 years) in which a drop of various specified magnitudes from a recent high was followed quickly by a resumed up-trend, rendering the sale unnecessary.

We discovered that by changing an automatic stop-loss from 8% (below the high) to 9%, we could cut the percentage of unnecessary sales at a loss in half. Further research revealed that after a drop of slightly over 14%, there was another dramatic drop in the number of "whipsaws." A drop of this size was significantly less likely to be recovered by the stock in the near future than for all drops of less magnitude. Therefore, a stop-loss of 15% does make a lot of sense. Sometimes, however, stocks do recover. There is absolutely no way for a person who uses stop-losses to avoid selling some stocks just before they resume an up-trend. Regardless of where the stop-loss is set, this will sometimes happen. It can only "know" what iS (the information that is available at the time of the sale).

When we decide to keep a declining stock, it is because evidence suggests it is the best thing to do under the circumstances at that moment, not a week later or even 5 minutes later. By definition, hindsight never exists in the present. Therefore, we will sometimes be wrong. If we keep the position and we are wrong, our loss might be 15% on that one position. However, we will probably be right more often than if all stocks are automatically sold under a stop-loss discipline that automatically sells on any decline of less than 15%. That does not mean a stock should always be given latitude to drop 15% before it is sold. The patterns of support and resistance (demand and supply) displayed on a chart of the stock are mitigating conditions. We have found that setting the stop-loss at about 15% for long-term investments generally works well as the maximum decline allowed, but many stocks should be sold long before that. For example, if there is obvious strong support 2% below the current price there is no need to set the stop loss at 15%. On the other hand, an investor could make it a rule that no stock is to be purchased if it is reasonable to set the stop loss any more than 15% below the purchase price.

We analyze support and resistance zones for each stock. When stockdisciplines.com traders buy, they buy with reference to a pre-determined stop-loss that is based on their analysis of supply (resistance) and demand (support) zones. They calculate the stop-loss before they buy, and they buy a stock only if a decline to the calculated stop-loss is tolerable in view of the gain expected. The market does not remember or care where anyone buys a stock. However, it does "remember" past regions of support and resistance. Technicians can see the shapes of these regions in the chart of a stock. Remember that a chart is simply a record of the effect of supply and demand forces on stock behavior. Price and volume movements do tell a story.

If a stock has very strong support 2% below its current price and it declines, breaking through that support, it is not likely to rebound soon, if at all. The same thing is true if a stock has built a good "base," is bought on a subsequent breakout through overhead resistance with a large increase in volume, and then it breaks down enough to trigger the stop loss. It is unlikely that we will regret the sale later. The conditions are defined sharply enough for us to render an accurate assessment of where the stock should be sold. Thus, it is not necessary to set the stop loss at 15%. Even if the maximum loss permitted is 15%, the average loss would likely be a much lower number. If the average is 8%, the greater flexibility available through support and resistance analysis will yield much better investment results than would be possible if a person rigidly sold all stocks when they were at a loss of 8%. Support and resistance analysis should enable the investor to avoid many "whipsaws" that could not be avoided with a more rigid system. In many cases there would be a profit where a more rigid system would have sold at a loss.

Changing the number of positions your portfolio is designed to carry could be a means of modifying the foregoing. For example, a twenty position portfolio could allow a stock to drop 20% without it inflicting more than 1% worth of damage on the portfolio. However, allowing more than a 15% decline did not produce any further improvements. In our view, therefore, there is little reason for most investors to expand the number of portfolio positions to more than 15 stocks. What we have said is based on the premise that the investor does not want to allow any position to be capable of damaging the portfolio more than 1% in a worst case scenario. If the investor wants the potential damage due to a single stock to be limited to no more than .5%, then the portfolio should contain 30 stocks.

However, our research showed that allowing a 15% decline for the stop loss dramatically reduced the chances that the stock would turn around immediately after it is sold. This information can be a powerful tool that a long-term investor can use to shape his stop loss strategy for maximum effectiveness. It can be used to set the tolerance for the negative impact of any single stock on a portfolio at any level the investor desires. To keep that 15% drop from impacting the portfolio more than 1%, the position cannot represent more than one-fifteenth of the portfolio. From this perspective, then, a 15-position portfolio is optimum for a long-term investor.

Copyright 2009, by Stock Disciplines, LLC. a.k.a. StockDisciplines.com

Day Trading - Top 5 Tips For Day Trading

Sat, 28 Mar 2009 12:06:50 -0700

Looking at the unpredictable behavior of the stock market people are indulging in day trading by the day. This way they do not plan to keep a stock for months or years, rather quit the moment they find 2-5% profits. This also helps them to make a sort of daily income from day trading. There are also some smart investors who enter the market as soon as it dips 10-15% and quit the moment it recovers back to same point or close to it.

Now can everyone do it with this ease, ask yourself a question had this been so easy then most of us if not everyone would have been in stock trading? You simply cannot go in there and start making big profits from it. You need to have some basic knowledge about company profiles, their balance sheets and their stock trading range. Having this knowledge will help you to make a decision when the stock hits a low and is a good buy. Some of this knowledge is important even if you are planning to keep stocks for a longer period of time, as the better the stock the better returns will it give over a period as compared to the other which are not performing that good.

To make decent income in day trading you need to follow certain principles:

1. Stay updated with the market news and spend some time on global news also. Most markets are driven by global factors. Although there are some local triggers that help the local market to behave differently. You do not have to spend hours to get all the news. Well headlines say it all in 90% of the cases. Make a list of 2/3 financial sites that will help with daily news. It is always better to subscribe to their news feed if available, so that it is delivered to your mailbox. This will help you take some actions if some trigger is about to change market situation.

2. Make a list of some select stocks and keep a check on their movement. Do not make a huge list which you will not be able to manage. Say about 10-15 stocks should be good enough. Do select about 4/5 market mover stocks in your list. Market mover stocks are those which can take market in any direction on their day, these are also known as major stocks. Make a note of these companies and go through their profit loss for past 3/4 years. Also keep a check on how their profits/loss is increasing or decreasing. The purpose of this exercise is that if you are stuck with a stock at higher price then keeping that stock some more time will not lead to loss.

3. Stay away from stocks that do not move. Any stock that shows a movement of less than 1% in a day is not good for day trading. Well some of these stocks may be better if you want to keep them for a longer period of time but definitely not for day trading. Any stock that moves at least 3-5% in any direction is good for day trading. Well you still have to keep an eye on whether it is on its low in the day or has already hit a high.

4. It is very important in day trading that you keep a stop loss and be prepared to book loss when a stock starts to move in a direction other than that you predicted. You do not have to b emotional when you make any decision. Base your decisions on quantitative analysis rather than your instinct. The bottom line is do not try to relate stock market with gambling. In gambling you go with instinct, but that is not the case with stock market.

5. Most important, do not try to evade profits from previous day by making moves in a hush-hush manner. Start every day with a clean slate, move cautiously and plan your entry and exit carefully.

It may not be possible to get wealthy with day trading in a short time, but if you make good use of your time, apply proper strategies, make good use of tools and resources available you can definitely unleash the potential that day trading has to make a fortune.

The Triple Moving Average Crossover System

Thu, 19 Feb 2009 06:24:07 -0800

The triple moving average crossover system is used to generate buy and sell signals. Its buy signals come early in the development of a trend, and its sell signals are generated early when a trend ends. The third moving average can be used in combination with the other two moving averages to confirm or deny the signals that they generate. It thereby reduces the chance that the investor will be acting on false signals.

The shorter the moving average, the more closely it will follow the price trend. When a stock begins an uptrend, short-term moving averages will begin rising far earlier than longer-term moving averages. For example, if a stock declines by equal amounts each day for 50 days, and then begins to rise by the same amount each day for 50 days, the 5-day moving average will start to rise on the third day after the change in direction, the 10-day average will begin to rise on the sixth day after the change, and the 20-day average will begin to rise on the eleventh day. The longer a trend has persisted, the more likely it is to continue persisting, up to a point. Waiting too long to enter a trend can result in missing most of the gain. Entering the trend too early can mean entering on a false start and having to sell at a loss. Traders have addressed this problem by waiting for three moving averages to verify a trend by aligning in a certain way. To illustrate, we'll use the 5-day, 10-day, and 20-day moving averages. When an uptrend begins, the 5-day moving average will start rising first. Traders view this as interesting but of no major significance. As the upside momentum increases, longer moving averages gradually begin to follow suit.

A buying alert takes place when the 5-day crosses above both the 10 and the 20. That is, the average price of the stock over the last five days is greater than its average over both the last ten days and the last twenty days. This shows a short-term shift in trend. A buy signal is confirmed when the 10-day then crosses above the 20-day. The 10-day average price of a stock is more meaningful than the 5-day average price. If the average price over the last ten days is greater than the average price over the last twenty days, the shift in momentum is considered to be much more significant. Conversely, when an uptrend changes to a downtrend, the first thing that happens is that the 5-day declines below the 10-day and 20-day averages. This constitutes an alert that a sell signal may be forthcoming. The confirmed sell signal occurs when the 10-day crosses below the 20-day resulting in an alignment in which the 5-day average is below the 10-day average and the 10-day average is below the 20-day average. More aggressive traders often use the alert crossover as the actual sell signal because it locks in more of the profit. However, the risk of doing this is that the stock may only be "catching its breath" before continuing its advance. The confirmed sell signal could then take place at a much higher price. Therefore most traders consider the signals to be generated by the 10-day crossing the 20-day.

I recommend using the 5-day moving average as a filter for each crossover event. That is, alignment can be used as a tool to reduce whipsaws. For a buy signal, the appropriate alignment is for the 5-day average to be above the 10-day, and for the 10-day to be above the 20-day. For a sell signal, the 5-day would be below the 10-day and the 10-day below the 20-day. If the 10-day has just given a buy signal by crossing above the 20-day average, a trader might abstain from making the purchase if the 5-day is now declining or below the 10-day average. The purchase would be made only if the 5-day resumes its ascent or is above the 10-day average while the 10-day average is still above the 20-day average. If the 10-day average gives a sell signal by crossing below the 20-day average, the trader might abstain from selling if the 5-day average has turned and is now rising, or if it is now above the 10-day average rather than below it. The sale would be made only if the 5-day resumes its decline or falls below the 10-day average while the 10-day average is still below the 20-day average. Traders at stockdisciplines.com have learned through experience that using the 5-day average in this way can dramatically reduce whipsaws (untimely and unnecessary buying and selling). The reason these alignments are important is because the shorter moving average is extremely sensitive to the development of a counter-trend in the stock's price. If a trend counter to the trend indicated by the crossover of your major moving averages is developing, it makes sense to wait for that counter-trend to dissipate before taking action.

Investors and traders might be wise to incorporate another indicator into their decision-making. To increase the reliability of the signals given by the system outlined above, it might be wise to use the 50-day moving average as a context and reference. The best and most profitable time to buy a stock is early in a new trend. Later buy signals carry greater risk that the stock will soon decline (because stocks don't go up forever). Therefore, if the 50-day average has been in a significant decline and is now leveling off or just beginning to rise, a buy signal using the triple crossover method outlined above has a greater chance of success than if the 50-day average has been rising for a long time, or is beginning to level off or decline after a prolonged advance. In other words, the intermediate-term 50-day average can be used to confirm and "support" the signals given by the shorter-term moving averages. Generally, it's better to avoid buying a stock if its 50-day moving average is in decline. A short-term trader might make an exception to this general policy in order to profit from a snap-back toward the declining 50-day average from an extreme oversold condition.

Copyright 2009, by Stock Disciplines, LLC. a.k.a. StockDisciplines.com

Buy and Sell Signals of A Moving Average System

Sat, 14 Feb 2009 06:00:57 -0800

One of the main problems with using moving average crossovers as actionable signals is that stocks may whipsaw back and forth across their moving average. It is therefore an advantage to wait for a good "setup" before acting in order to avoid being whipsawed in and out of the stock (and to avoid excessive trading commissions). Whipsawing occurs primarily when the stock is not trending. Traders use other tools to identify non-trending situations early so they can switch to strategies that work better in non-trending environments. Most traders who use moving average crossover systems consider any extra trades they might make to be the price one must pay to be positioned correctly when the stock finally stops whipsawing and begins to trend. In general, traders consider the benefit of the strategy to be that it enables a trader to enter a position close to the beginning of a trend and to leave near the end of the trend.

Some traders reduce the number of "false signals" by using the move of a short-term moving average across a longer-term moving average as the signal mechanism rather than the crossover by a stock's price. A 5-day moving average is less likely to whipsaw back and forth over a 50-day moving average than is the closing price of the stock. Traders use combinations of moving averages (like 5 and 30, 5 and 50, 20 and 200, 10 and 100 and many others) based on how active they want to be as traders. The longer the moving average, the better established the trend it represents and the less likely it is to be generating a false signal. On the other hand, longer moving averages give up more of the profit potential of a trade because they are slower in generating their signals. There are tradeoffs here that only the individual trader can resolve through experience. Remember that the rising trend of an undervalued stock is more likely to be sustained (less likely to break down) than the trend of an overpriced stock. Price relative to earnings (PE or PE-ratio), sales (PSR or Price Per Sales ratio), and earnings rate-of-growth (PEG or PEG ratio) are among the factors that give fuel to the momentum of a trend. Sometimes investor psychology does too, but trends based on psychology alone are more apt to undergo unexpected reversals.

The following rules pertain to moving average resistances, supports, and crossovers. A stockdiscipline.com trader has tested both exponential and simple moving averages and has found that a simple moving average is preferable to an exponential moving average. This is information you are not likely to find in the media where the common perception is that the faster exponential moving average is to be preferred. The longer the moving average, the more reliable these rules tend to be. Many investors strictly adhere to the following moving average rules. However, we make no recommendations to buy or sell any specific stock.

1. If the moving average line flattens out after a significant decline, or has begun to rise, and the price of the stock passes upward through the moving average line, it is considered to be a buy signal. The same holds true if the moving average flattens out or rises after the stock has passed upward through the moving average line.

2. If the moving average is still rising aggressively and the price of the stock falls below the moving average, this is considered to be a buying opportunity.

3. If the stock price is above the moving average, declines to the moving average but fails to go through it and starts to turn up again, this is a buy signal.

4. If the moving average is declining and the stock price falls under it too fast, it is likely to return to the moving average. The stock can be bought to profit from this short-term snap-back. It is generally best to wait for some sign that the downward momentum is abating or that it has actually reversed before the purchase.

5. If the moving average has been rising and then it flattens out, or if it is declining, and the price of the stock passes down through the moving average, it is considered to be a sell signal. The same thing holds true if the flattening out of the moving average or its decline occurs after the stock has passed downward through the moving average.

6. If, while the moving average is falling, the price of the stock rises above the moving average, this is also an opportunity to sell at a good price before the stock resumes its decline.

7. If the stock price rises toward a moving average from below, but fails to go through it and starts to turn down again, the resistance offered by the moving average is too strong for the stock and it is a sell signal.

8. If the stock price moves rapidly above the rising moving average line too fast, it is likely to have a reaction move back toward the moving average and the stock can be sold for a short-term technical reaction. It is generally best to wait for some sign that the upward momentum is abating or that it has actually reversed before the sale.

It is wise to use more than a moving average to define buy and sell points. Shrewd investors learn to use a variety of indicators in concert. It is also helpful if the stock's fundamentals are in alignment with the signal generated. For example, if the stock has given a buy signal, it is a big advantage if the stock is also undervalued. Following a discipline adds clarity and purpose to an individual's trading. It also enhances a person's resolve when emotions run amok and the circumstances create confusion and indecision.

Copyright 2009, by Stock Disciplines, LLC. a.k.a. StockDisciplines.com