Greetings, fellow Pro-fundity team members -
3-12-99 Page

A Rolling Stock Fireside Chat

Last week we discussed a strategy with rolling stocks that took advantage of Buy and Sell Stop orders for both the entry into a stock position and the exit. We started to analyze (SUPX) to see how close to the ideal return we could get. We are taking this time and going into this detail for the benefit of subscriber requests. We welcome reader comments and questions for help in focusing future editorials.

Looking at the chart above to assess its value as a roller, we see seven distinct rolls for possible profit. A perfect world would calculate the return from the very bottom of each roll to the very top, obtaining the ideal result shown below:

1. Rolling Stock Strategy #1
   
   Before we begin a paper trade on this roller, lets re-examine the strategy outlined last week. This strategy requires monitoring a stock each day to watch for signals that tell us when to buy and when to sell. In this strategy we buy the stock when:
   • it appears to bottom, then
   • has successive up-ticks, then
   • reaches a price at some value above the closing price on the last up-tick.
   
   [This reduces our risk of buying a stock near its bottom, then watching it continue down]

   We then sell the stock when:

   • it appears to reach a top, then
   • has successive down-ticks, then
   • reaches a price at some set value below the close on the last down-tick.
   
   [This reduces our risk of selling a stock near its top, then watching it climb further into the sky. That is, we have put no arbitrary limit on how high the stock can go. We let the stock tell us when to get out.]

   We are asking for confirmation on both the buy and the sell that the stock is indeed moving in the right direction. If we only place a trailing stop somewhere below the current price, we can be whipsawed by momentary spikes that would execute the sell-stop before its time.

   Will it always work? Certainly not. Will it work often enough to justify its use? The only way we will know that is by having market experience. Paper trading can give us that experience for only the cost of the effort to do it. Experience will equal success.

   Let's test this strategy by paper trading. How do we know if 1 tick up is better than 2? How do we know if 1% or 2% after a tick or two is the best level for our stop orders? We paper trade... a lot! Consider it a hobby - that becomes a business - a profitable business.

2. Paper Trade Analysis

   To purchase a rolling stock at or near its support level, we will choose a two-parameter criteria:

   • A number of up-ticks in succession to tell us the move is real.
   • Further confirmation with a buy-stop order some % level above the price on the last up-tick. (The buy-stop becomes in effect an additional up-tick required for the order to execute)

   Does it work? We will only know if we try! This is the value of paper trading.

   For instance, lets take the 10 Pro-fundity Picks from 2/19/99 and test our strategy for two weeks, 2/19/99 to 3/5/99, with the following parameters:
   
   

   To buy:
   Up-ticks: 1 or 2
   % above last price: 1% or 2%

   That sounds easy enough. But when we consider the same test for selling the stock, sixteen combinations of parameters are required. Only two stocks of the 10 are shown in the following table. The complete table with all 10 tickers is included at the end of the editorial. If you can't stand numbers, focus on the concept with the summary and conclusions later in the editorial.
   
   

   

   The result of this analysis is important for us all. For these 10 stocks, the highest returns occurred with 1 up-tick and 1 down-tick. For this set of picks, five stocks gave us adequate results, five did not. Reviewing the charts on these five show the reason for the poor result was not the strategy, but the poor movement of the price charts. The numbers below are the average of four sub-strategies tested, numbers 1, 5, 9, and 13 in the table above, which represent the combinations where both up and down-ticks were 1.
   
   

   

   For this strategy, with these stocks, at this time, one tick is better than two. That means that for the volatility of the stocks tested, the one tick plus the second confirmation of the buy-stop above the last price (requiring then two successive increases) is sufficient to capture gains. See the complete table at the end.

   Before we leave this, lets see an example where two ticks would be helpful as we mentioned in Part 1 last week. Consider the price chart below. Suppose we own the stock and want to sell at the top. One way to know if it has reached the top is to see real evidence that it is turning down. If we use one down-tick with a 1% below-level sell-stop, we would get our first down-tick on 1/13/99. A sell-stop would be entered 1% below the last price of $16.55 or at $16.40. This would execute the following day when the price fell through that value to $16.00. So we got out of the position near $16.40.

   If we had chosen 2 down-ticks for the strategy, the first 2-successive down-ticks occur on 1/14/99, but a sell-stop here will not fill because the next price is higher. 2/5/99 is the next combination where we would set a sell-stop 1% below the last close. That sets the flag at $17.57 which will execute the next day as the price drops to $16.44. The two-tick gets us $1.17 more ($17.57 - $16.40). The price data is shown below the chart for those interested in following the detail.
   
   

   
   
   
   

3. (SUPX) Rolling Performance

   Lets return to our consideration of the (SUPX) price chart at the beginning. Working each of the seven rolls in the chart with lessons learned from our analysis of the 2/19/99 picks, the following returns are achieved (Buy: 1 up-tick plus 1% buy-stop, Sell: 1 down-tick minus 1% sell-stop):
   
   

   

   Notice, on the C-D roll-up we had three buys and sells, not all profitable. Similarly two each for G-H and K-L. We said last week if we were able to get half of the ideal we were in excellent shape. (SUPX) was a good roller for this strategy.

   Observations: There is a give-and-take as we set parameters for trading. If we increase the number of up-ticks required or % above buy-limit before we buy, we will eliminate a lot of the noise that results from the normal volatility of this type stock. That means we won't buy stocks going no-where as often. However, if we use too many signals, we lose some of the value in the trade. That is, by the time a stock has risen two or three up-ticks, the buy is so close to the sell we don't get much return. We can virtually eliminate any whipsawing, but miss some good trading opportunities. Whether we use one, two or more depends upon how fast the price increases or decreases! If the rise is a two or three-day spike, two up-ticks will miss it. If the rise takes a couple of weeks, three or four is not unreasonable. This is where the experience of the market provides insights working with different stock price patterns. Market insight!

4. Rolling Stock Strategy #2

   Look at the price chart for (SUPX) again at the first of the editorial. If we bought the stock near its bottom at point A, we could simply ask ourselves what would be a good return and set that as a target on the upside. We could do this if we had confidence in the company's fundamentals and were certain it was going to survive. It this case, 10% above a price of say $12.60 would be $13.86. We can place a sell-limit at that level and simply let nature take its course.

   In this example, this order would fill on 12/3/97 and we have our 10%. If a stock is rolling consistently within a channel where the top & bottom are reasonably predictable, we can buy the stock in the same way. This would be a little tough with (SUPX) in this time frame but look to the right in the areas between I and N. The support and resistance levels here are pretty well defined.

   Had we sold the stock near J, we could put in a buy-limit order at something over $9 using the prices around I as a guide. Lets pick $9.20 for a little cushion, and wait for the order to fill at K, which it does on 8/4/97. Next, place a sell-limit at a reasonable increase. 10% would bring it up to $10.12, but that is only half the distance to the previous resistance level at J. Be aggressive and set the next sell limit at $11.25 and wait! This fills on 8/13/97, and on it goes. See how much fun it can be to take aggressive positions doing paper trades!

5. Using Stochastics for Buy-Sell signals, Strategy #3

   Refer to the price chart with the stochastics indicator below. We learned in the Technical Analysis tutorial that the stochastic indicator is a measure of when the stock is over-bought or over-sold. A good rolling stock can use this indicator to predict buy and sell signals.
   
   

   

   The critical signals are where the stochastic curve crosses its moving average, sell at the top, buy at the bottom. The dashed lines help identify these points. In the example above, the first half of the chart is a disaster for the stochastics as a predictor. This is because of the erratic price pattern. It gets a little better in the second half but this is not a good smooth roller where the indicator will accurately predict entry and exit points.

   Take time to examine this tool while working with rolling stocks. It can be very helpful with smooth rollers having a lot of volume. The statistical nature of the indicator thrives on volume. It is less reliable with low volume stocks with erratic price patterns.

6. Paper Trading Going Forward

   As we engage in active trading on a roll, having learned all we can through weeks or months of paper trades, we need to deal with the current market. This section demonstrates the use of real-time quotes for those subscribers who can look at the market real-time, where active and current market data are used to drive trading decisions. First, lets take a look at an important service available to us at no charge.

   Log on to the net at http://www.thestockpage.com. You will be asked to register and receive a login and password which will take about 5 minutes. When you get in, enter a ticker symbol and get a real-time quote. This will give us the last session closing price, the open price for this session, the volume so far this session and the current bid and ask prices. Remember, we have to pay the "ask" price to purchase and receive the "bid" price when we sell. Be sure to keep these straight in the paper trades to keep an honest track-record for later consideration.

   From this screen you can go to a chart of the stock, news, SEC filings, and general market information, that is, current DOW, AMEX or Nasdaq performance levels. This a treasure trove of information as we get actively involved.

   You can sit at this site during an active trading session and update the quote with a Re-Do It! Button. You can go to interactive charting, click Indicators, Lower Indicators, Slow Stochastics, then click the Draw Chart button. The Blue line is the stochastics with its moving average in Red. Where these two lines cross, it signals potential buy and sell conditions, sell at the top, buy at the bottom.

7. Conclusions:
   1. We observed two different characteristics of a rolling stock by comparing (SUPX) with (MTON). These differences may modify the strategy we select as we develop market insight through a lot of paper trades. Other differences will become apparent with experience. A very important point here is that successful trading involves a lot of intellectual input on our part. That is, we can't simply develop a routine, put it on auto-pilot and go swing on the porch.
   2. We have discussed three different strategies for playing rolling stocks. They can be used independently or in concert, looking for agreement to strengthen our position.
   3. Strategy #1 uses alternative buy-stop and sell-stop orders to get the most from a roller. Since most internet brokers will allow only one active order on a stock at a time, the use of a sell-stop precludes the use of another sell-stop placed as a safety net or "stop-loss." The point is it's okay to use this order as a trailing stop, moving it higher as the price moves up, protecting our paper gains as it moves. We cannot be careless and wait for the price to increase before putting in this sell-stop. We must protect our down-side at all times with some level below the purchase price where we're not willing to lose more. If we must, keep a "mental" stop-loss mindset, ever ready to act when appropriate. Remember the comment last week, the key is not in always making correct picks, it is in cutting our losses quickly on those that do not follow the script, to lose as little as possible when we are wrong.
   4. Chart reading can be a rewarding and enjoyable task. We have only talked about the stochastics indicator to predict buy and sell triggers. There are others we will discuss in future editorials. There is a wealth of information available free on the internet, some of which we have discussed in this editorial. For the serious mind, charting services will pay for themselves easily as they become a default exercise in picking and working rolling stocks. We use TC2000 as a critical tool in selecting our weekly picks. Serious and detailed study of the Investors Business Daily is another important tool for us.
   5. Going through the paper trade on the 2/19/99 picks we saw the value of dealing with stocks one at a time, rather than as a group. In our "How'd we do last week" section we show the aggregate return on the 10 picks comparing closing prices on the page-Friday to closing prices seven days later. This has no consideration of what takes place during the week. For instance, the two weeks we did the paper trade, the aggregate return (that measured by our "How'd we do") was a minus -0.83%, with 5 gainers, 4 losers and 1 unchanged. Yet we were able to return an aggregate of +3.52% over the same two weeks by working the price movements during that time.
   6. There is a light at the end of the tunnel! While this may seem overwhelming at first, a routine can evolve which takes a minimum of effort. It does not require sitting at a computer terminal throughout the trading session. Day-trading is a difficult and seldom rewarding activity. The focus of this site is to develop principles we can use in the evening for maybe 30 minutes each day. By setting alternative orders with our brokers, we come as close to auto-pilot as possible.
   7. We will pursue these issues in future editorials, building line upon line. Let us hear about what you want to learn.

Complete data table for the paper trade analysis of the 10 stocks picked on 2/19/99, for all combinations for Strategy 1: