Greetings, fellow Pro-fundity team members -
2-9-01 Page

This Week's Guidepost

What about Timing? When should I sell?

1. Last week we punched up the importance of Fundamentals in making quality stock picks. Sure, our focus is and has been on “Swing Trading,” whether we call it channeling or rolling stocks or market timing. But Pro-fundity takes the position that as long as we are choosing volatile stocks to ply our trade, why not develop a data base with a positive bias, a body of stocks that are more likely to increase in the long-term? It is that group of companies that will be around for years down the road. We can see that principle at work by checking our pick success. The following table shows this performance going back nine weeks. Point: This performance compares the price on the date of the pick to the price at last Friday’s close. This is a “Buy & Hold” comparison, without regard to any advantage we also gained by interim trading.

   

2. The value of the Pro-fundity service lies not in its ability to choose long-term Buy & Hold positions but in selecting volatile tickers that we can trade for greater return. For instance, a pick made on 12/29/00, MXT, shows up as a loser on the table. It was picked at $26.31 and closed last Friday at $24.36. The following chart shows that it increased to $31.63 on 1/11/01, a 20% gain, before falling to its present price. That was a good rolling play where we should have picked up 10%. All of the data in the table only reflects Buy & Hold performance. But it is this data base, with a 10% positive bias, that we find lucrative in exercising our trading skills (Note: The S&P 500 index increased from 1312 on 12/15/00 to 1315 on 2/9/01,+0.23%!).

   

3. In the chart above the red marker shows where the pick was made and the heavy line shows the date of the high-point, where the data at the top is referenced (1/11/01, Open, High, Low, Close, Volume & % Gain). Okay, this was a 20% increase. Would we have been smart enough to capture it? What guidelines should we follow to “Sell” at the right time? Let’s consider this critical issue in trading volatile stocks successfully. The previous chart is expanded to look more closely at action we might have taken to capture the gain.

   

4. In our book “Provident Investing,” one strategy we discuss is using a trailing stop, moving it higher as the price moves up, to protect our gains. For instance, as the price on MXT moved from our buy-point ($26.31), if we placed a stop-loss at say $25.00, 5% below, the next days action would stop us out since the low for the day ($24.50) was below $25.00. Even tough the close was above our stop, the low kicked us out. The stop we use upon the initial purchase is obviously not to protect our gain, but to get us out of a losing position with minimum loss. However, it is this stop that we move up to protect gains as they develop.

5. 5% was too close for this example, we missed the gain. If we placed the stop at 7% below ($24.47), we would stay in our position until 1/12/01 which would get us out at $29.41, or 7% below the close on the previous day which was $31.63, a 12% gain (less commission). Here is what that would look like, moving the stop up each day relative to the closing price.

   

6. It should be clear there is a tradeoff using trailing stops. The closer we place the stop to the price, the more we will make on the trade. However, we will be stopped out of trades more often by market noise. A helpful guide to this choice of stop level is the volatility of the stock. More volatile stocks require a larger stop percentage to avoid being kicked out by random variation. We can get this on the chart data for each pick by looking at the Average True Range (ATR) which is calculated and presented as a percent of the price, for both a five and a fifteen day snapshot. This is the table below each chart for picks on the Pro-fundity Page.

   

7. For MXT the ATR was 4.8 and 5.2% respectively. We’ve seen the 5% stop was too close. We need to exceed the ATR somewhat to avoid the noise. We found that 7% worked okay. The ATR is a measure of the noise in the market for a particular stock. The next chart presents the same problem with a Pick offered on 12/15/00, CANI. We have considered this ticker in previous Guideposts and need to exercise our trading skills here.

   

8. CANI was offered as a Breakout on the date shown by the red marker. It rose from the pick at $27.56 to a high of $39.50, a gain of 43% in 19 trading days. The ATR for CANI was 19.1% and 23.3%, a very volatile stock. Had we used 20% as a stop, we would have missed the drop until the second leg down, stopping out at $27.30, less than we paid. This shows how too large a percentage for the stop will often reduce our return. A 10% stop we would have sold twice, at $31.28 and at $34.88. This could have returned over 20% had we bought back in after the first sale.

9. So where does this leave us? It has been said that successful trading in the market is more an art than a science. That may be true to a degree, however most successful traders in my experience use a lot of science to bolster their “art.” An understanding of the principles illustrated in this Guidepost will help each of us gather the inputs we need to make informed decisions. A matter of fact: None of us will find success by copying the strategies of others. It depends too much on the emotions of individuals when “pulling the trigger” on buys and sells. We have to find what works best for ourselves, what we each are comfortable with. That is not to discount the value of knowing what others do and how they do it. It is in understanding the many different approaches to successful market trading that we are each able to synthesize our own strategies. That is why we cannot just log onto the net as a trader for the first time and watch the money roll in.

10. We have emphasized the value of doing paper trades to exercise the many possible trading strategies. What great practice. However, when we put our own money on the line, there is a measurable change in the way we react, in the way we act, in the speed with which we take action. That is where we ultimately get our education, on the line. Someone said how great his trading was going, that he picked XYZ stock at the very bottom and it has increased 8 times since. Wow, sounds great. But when asked if he was going to sell now, he responded that he hadn’t bought, only made a great pick. We’ve all been there, lets share our experiences with each other as we make this journey. Stay tuned.

It is our intent to help our subscribers understand market strategies well enough to make informed decisions and understand the risks.

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