Greetings, fellow Pro-fundity team members

1. When Michael Marcus (trader extraordinaire) was asked by Jack Schwager (“Market Wizards,” New York Institute of Finance, 1989) “What other advice would you give the novice trader?” Marcus replied, “Perhaps the most important rule is to hold on to your winners and cut your losers. Both are equally important. If you don’t stay with your winners, you are not going to be able to pay for the losers.” This is the reasoning of the past few Guideposts, as we study different exit strategies. This week we will review yet another strategy that tries to incorporate this message, Relative Strength Moving Average (RSMA).

2. Before we launch into this different approach, the question is asked, “Why not just study the best approach, eliminate the fluff on the sidelines and place our efforts where they will do the most good?” Excellent question, one that has driven the Pro-fundity effort these five + years, and one we’ve addressed on numerous occasions. Let me borrow from the Schwager/Marcus interview again:
   Schwager, ”What kinds of misconceptions about the markets get people into trouble?” Marcus, ”Well, I think the leading cause of financial disablement is the belief that you can rely on the experts to help you. Typically, these so-called ‘experts’ are not traders. Your average broker couldn’t be a trader in a million years. More money is lost listening to brokers than any other way. Trading requires an intense personal involvement. You have to do your own homework, and that is what I advise people to do.” Further, Marcus says, “You have to follow your own light. Because I have so many friends who are talented traders, I often have to remind myself that if I try to trade their way, or on their ideas, I am going to lose. Every trader has strengths and weaknesses. Some are good holders of winners, but may hold their losers a little too long. Others may cut their winners a little short, but are quick to take their losses. As long as you stick to your own style, you get the good and bad in your own approach. When you try to incorporate someone else’s style, you often wind up with the worst of both styles. I’ve done that a lot.”

3. Sounds easy enough, but where do we learn what style fits our personality? By trying them! We need to be exposed to as many different styles, strategies, methods, and trading techniques as possible. We can try them side-by-side, at the same time, on the same set of tickers, with the back-trading and paper-trading tools listed in our Advanced Tools link. This way we can find a personal trading style to work on, to improve as we become active traders. Let’s examine RSMA, as an exit strategy.

4. ”Relative Strength - The price strength of an individual stock compared to the strength of an industry index or general market index. Generally, when a stock acts stronger than its industry or the market as a whole it is a bullish indicator for that stock.” This is one of the four “critical additional news items” provided every day in the “Investor’s Business Daily” stock tables, items not found in the Wall Street Journal. They report the relative price performance of each listed stock during the last 12 months (a measure of today’s price compared to price 12 months ago). The number for each stock is compared to all other stocks and placed on an easy-to-use 1 to 99 scale. A relative strength number of 80 means the price of this stock outperformed 80% of all other common stocks during the past year (price-wise).

5. We vary the price-strength concept, comparing the stock price to the S&P-500 graphically. Since the S&P is the most often used index for the market, this will compare our ticker to market strength. First, the following chart shows the S&P-500 over like the most recent five months.

   
   

   

   Fig. 1

6. The index fell until the first of March, showing an increase from there. Now, look at the following chart of EYE, continuing last week’s analysis as we look for a profitable exit.

   
   

   

   Fig. 2

7. This chart shows some similarity to the S&P, but to make the comparison more clear, the next chart puts both patterns together.

   
   

   

   Fig. 3

8. The S&P and EYE follow similar patterns in this chart. The Relative Strength of EYE compared to the S&P is a measure of the difference between these two patterns. There is not much difference from March through April. To see a better example between a stock and the S&P, look at the next chart, using FOSL as the stock.

   
   

   

   Fig. 4

9. In this comparison, when the S&P is higher than the stock, the relative strength is below by the same amount. This red Relative Strength line then is a graphical measure of the difference between the stock and the S&P. Notice, the previous chart was drawn with both the S&P and the Relative Strength line to help understand this principle. However, it is not necessary to include the S&P as shown in the next chart. This shows a stock price chart with its relative strength (relative to the market). This is all we need to understand what follows.

   
   

   

   Fig. 5

10. Now lets return to the ticker in question, EYE, with its relative strength line.

    
    

    

    Fig. 6

11. As price has increased from the first of March, the pattern follows the relative strength very closely. This means EYE shows no weakness with respect to the market. But there is a much better way to measure weakness. To get into that, consider the value of a simple moving average of the price pattern. In the chart below, two moving averages are used to signal changes in a trend, finding the point where the shorter MA (7 bar) crosses down through the longer MA (30 bar). Different length MA’s are used for this purpose, but it provides a technical signal for a trend change.

    
    

    

    Fig. 7

12. A weakness of the price moving-average technique is the timing. Anything measuring price averages lags the real action. That is, the signals for trend changes are late, as seen in the previous chart. Since we’ve created the new RS pattern, we can use moving averages to signal changes in the relative strength. We get a sell signal when the short-term MA crosses down through the long-term MA. But this signal combination reduces some of the weakness in the price MA technique. Relative strength can begin to weaken while the price is still rising. This provides a sell signal not on weakness but on strength. On the other hand, a drop in the market causing a drop in stock price can kick you out of a stock with price MA’s. However, the RSMA is more forgiving and may show a resistance to the decline. The next figure shows the price chart for EYE with 7- and 30-day moving averages. The MA’s are of the relative strength line, not shown. But that is all we need. Refer back to Fig. 6 to see the RS line.

    
    

    

    Fig. 8

13. EYE shows no sign of weakness in the relative strength, suggesting no reason to sell now, even though we are up 68% on this date. Before we close on this issue, look at the next chart comparing the price MA (blue lines) crossover with the RSMA (green lines). This price pattern has turned, but the blue crossover occurs before the green, getting us out of the position at a better price.

    
    

    

    Fig. 9

14. The following table is the Watch-List performance of the 2/28/03 main picks, including EYE as well as SSYS, both dramatic increases. Should we sell? SSYS is shown below the Watch-List with RSMA. Again, the strength of the ticker does not show weakness. But how far can we let these winners run? Let’s review the progress next week as we summarize the exit strategies we’ve studied with other teachable examples. In any case, whatever strategies are used to make sell decisions, RSMA should play a major role.

    
    

    

    Fig. 10

    
    

    

    Fig. 11

    04-25-03 Pick Selection:

    Main Picks:
    AGEN,DPL,INTL,MYGN,NTEC,PR,RNA,TECH,TGI,USM
    Breakouts:
    AD,ADS,BCGI,JWA,MGAM,NKTR,PLT,TSFG,WIX,ZRAN
    QuickPicks:
    ALK,CEGE,CK,DQE,FBR,HHS,NTIQ,PLAB,SFD,WOR

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

    Be diligent
    Take Action!