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Greetings, Pro-fundity team members -
03-28-03

At the bottom of the Guidepost, a full listing of this weeks picks are shown, in addition to the Charts via the Pick-link.

As a benefit of membership, you have access to all Guideposts (including Archived GP's) and Picks. If you miss a week or two for whatever reason, you will be able to go into the Historical Guidepost link to catch up with both the weekly guidepost and the 30 picks made for the week.

Greetings, fellow Pro-fundity team members

1. We introduced the Reward/Risk ratio last week with a couple of examples. Question: If we are 100% certain the price of a stock is going up, should we invest all we have? A major portion? Half, 10%, … First, we never know 100% where the price is going. Certainty is in the past. We can guess, hope, speculate, fantasize, postulate, noodle, but never know! The market holds its cards close to the chest when it comes to prediction. It is tempting after a string of positive calls (during a bull market) to feel omnipotent. This is an emotional reaction we must thwart, called the Pogo problem; “We have met the enemy and he is us!” Rather, let’s manage our actions to protect against the negative while we “accentuate the positive.”

2. Back to the question: Although we can’t know with certainty which way the price will go, we can guess with some confidence: Based on past performance under similar conditions, what we know of the personality of this stock, actions of different indicators, sector and/or the market direction, etc. That confidence must be weighed against a reference, something that says, “it’s worth a gamble.” Not a gamble like roulette with the odds stacked in the casino’s favor, but a measured business decision. That reference is a judgment on how much we expect the price to rise. Isn’t it enough to be certain it will rise? Use a little common sense here. We do know that it won’t rise forever! So, looking at its historical record, we assess where the price is likely to go if it does rise. Look at the chart below, another pick made on 2/28/03. This is what the pattern looked like on the day of the pick. On that day, how far might we expect the price to rise?

   
   

   

   Fig. 1

3. If I’m a real positive thinker, I might say the upside is $12.40, shown with the dashed line at the top. There is another possible level at $10.50, the dotted line. What should we use? Notice the increased volume on that Friday, as well as the Stochastic pattern. Doesn’t this look like a roller we should invest in? Okay, why worry about where it will go? Isn’t it enough that it will likely go up? Not so fast. Since there is the chance it won’t go up, what’s the risk on the downside, how far down might it go? Another judgment call, but one we have control over, where we put our stop. Having guessed at the upside and defined a stop on the downside, we are ready to compare the reward and risk to see if this whole exercise is worth our time.

4. Unless the reward is greater than the risk, investing may not be a good call. How much greater? Enter the Reward/Risk Ratio. Since we each have our own risk tolerance, there is not a one-size-fits-all best ratio. A common value is 2, saying the reward must be twice the risk. I’ve known traders who used values from 1.5 to over 3. But here’s the point, they have a value they use and stick with! For the sake of our example, let’s use 2 as a default RR ratio. How does this pick stack up? Well, we need to place a stop.

5. The stop level can be approached different ways. The first and quickest way is to examine the price pattern and look for natural support/resistance lines, that is, levels where price found previous support and resistance. The next chart shows what might be a natural support at $7.30. It would not be out of place for the price to bounce off this level before moving up, whereas, a price move down through this level would signal a change in character. Changes in character occur for a variety of reasons, none of which are in our control!

   
   

   

   Fig. 2

6. Using this support level for our stop-loss ($7.30), the Risk becomes $1.33 ($8.63 - $7.30). Then, the RR ratio; Reward/Risk = ($10.50 - $8.63)/$1.33 = 1.41. That fails our RR criteria, however had we used the optimistic upside, the RR would increase to ($12.40 - $8.63)/$1.33 = 2.83. So, which view do we adopt?
   We need a side-bar here, to speak to the psychological side of trading. There are multitudes of trading strategies flashed across our screens, lo here, lo there. And the truth is they all work! If they didn’t work we’d never see them. But the bottom line lies in our individual psych-profile. That is, some strategies work better for one type, another for a different type. It’s a question of our own risk tolerance which is very personal, individual, and different. Where does that leave us? As we’ve said many times, the difference between success and failure is a thin line, with the balance tipped predominately to those who understand themselves as well as the market. We must learn what works for us. We learn that by experiencing different strategies, a lot of strategies, failures, successes, ho-hums, oops’s and oh-sh__’s. How can we do that without bundles of bucks and years in the trade? Paper-trading, back-trading, using the Advanced PTS trading tools at Pro-fundity. This is not a weekend activity to be told what to invest where for multi-$ returns. The market frowns on those promotions, but happily gathers participant’s money. So, experience the market, experience trading techniques, experience failure and success with Pro-fundity.

7. Let’s move ahead in time and see the price pattern as of this date. Leaving the pointer on the pick date, 02/28/03, we see where the price has gone:

   
   

   

   Fig. 3

8. The price did go up, reaching $10.36 on 03/21/03, before falling back a bit. That’s a 20% price increase from the pick date of $8.63 on 02/28/03. There are many possibilities here. A fixed 10% target would have captured the 10%. A 20% target would have captured the 20%. Are we ready to walk away now? Let’s take a bigger-picture look, using the weekly view as shown below:

   
   

   

   Fig. 4

9. The marker shows the pick date with the subsequent increase. From the “top of the trees” we see a dramatic price drop from May 2002 until the first of the year, with a bounce moving into what looks like a “decreasing wedge.” These often provide periods of indecision in market movement, with some good rolling opportunities. However, each succeeding roll in a decreasing wedge shows lower highs and higher lows, less attractive for rollers. The thing to watch is which way any subsequent breakout occurs, it can go up or down. Some hefty profits have been ours when the breakout is to the upside. But that’s a different strategy. The important point in this paragraph is how important it is to look at price charts in more than one time-frame. This is a must for any strategy!

10. In the next guidepost we will discuss another important method to set a stop-loss, using the Average True Range (ATR), as we continue this series on entry/exit strategies. Note: The techniques covered in this Guidepost require substantial judgment on our part. Where do we get the wisdom to make these judgments? By reading all we can get our hands on, but more importantly, by doing it! Stay tuned.
    03-28-03 Pick Selection:

    Main Picks:
    ABM,BEZ,CXR,HSP,IGLD,INSP,IPCR,LAB,NATI,QDEL
    Breakouts:
    ARG,DSCM,FAF,FMT,HITK,JCOM,PRA,ROL,STKL,WDC
    QuickPicks:
    APCC,CEN,HMC,LRCX,MNTR,NSCN,OSIS,SU,WWW,XEC

    For detail and followup on Pro-fundity Tradescape,
    find the link on "Advanced Trading Tools" on the home page.

    Be diligent
    Take Action!

    

    
    
    
    
    

    
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