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Greetings, Pro-fundity team members -
08-22-03

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 have emphasized the importance of placing a protective stop-loss at the same time we buy a stock. Our first stop-loss technique was a fixed percent value, which kicked us out of the position if the stock price fell below our stop percent. For example, the William J. O’Neal (IBD) default is 8%. Thus, it is sold if the price ever falls below 8% of the purchase price. We used the Personal Investment Planner (PIP) spreadsheet to try different levels for a fixed percent stop loss, finding tighter stops (closer to the buy price) gave us smaller losses, while wide stops gave us larger losses. However, the number of losses increased with tight stops, fewer with wide stops. There is no universal best stop. It’s a personal issue, the best stop being the one we feel most comfortable with. Your assignment last week was to paper-trade the Breakout pick list for 8/15/03, using a stop level of your choice.

2. Here is what the PIP looked like for a –8% stop and a 10% target. The first ten rows of the table is the standard format. We’ve added the daily closing price data for each of the ten tickers providing a convenient way to track each ticker for the class assignment. For this example, three tickers met the 10% sale criteria and one triggered a sale on the stop. Note the actual % gain in each case was less than the % trigger, due to the commission costs involved.
   
   
   Fig. 1 PIP for last week’s assignment (-8% Stop Loss).

3. Notice how we have changed the format of the PIP… These changes can be made by any user by un-protecting the spreadsheet. On the Excel tool bar, press Tools – Protection – Un-Protect. You are then able to format the spreadsheet for your own convenience. The real value in the PIP lies in the ability to change parameters and see the result. For example, since we have the spreadsheet already filled with ticker data, we can see the result for a change in stop-loss level. The next figure shows how performance changes by reducing the stop from –8% to –6%. The stop loss kicked us out a little sooner, with a smaller loss. We see this change by simply typing in the Loss cell –6% instead of –8%.
   
   
   Fig. 2 PIP with Stop Loss at -6%.

4. Next, lets increase the sell trigger to 12% and lower the stop to –10%. This gave us larger gains in two rows, another (PRST) was not sold, and a larger loss on the stop.
   
   
   Fig. 3 PIP with Sell-trigger and Stop-level changed.

5. The importance of this exercise is to taste the power of the PIP using different stops and trigger sells. We’ve suggested how important it is to find a system we’re comfortable with, a point parroted by all investing guru’s: “Find your own system!” But how do we do that without large capital outlays while the market teaches us harsh lessons? We practice, we paper-trade, we back-trade, we sense the personality of the market through trial and error, through wins and losses and by paying close attention to lessons learned. The PIP helps us do this!

6. This week we study another loss strategy, the Trailing Stop. With this technique, the loss level follows price during a trend, remaining a short distance away. In the previous “Fixed Percent stop-loss,” its purpose was to protect investor capital, what we start with. The trailing-stop helps protect profit, or the gains garnered since the original investment. The following spreadsheet shows an example on the $1,000 portfolio we created from picks made on 8/01/03. The Buy Dates occurred on the following week, with three stocks sharing the $1,000. We started with a 10% Target Sell with a –8% Stop-loss as shown. Daily closing prices are shown below the tickers going forward, with the initial Stops shown in blue. The point here is to increase the stop loss each time there is a price increase above the previous high. For example, notice how the price of NEM increased from the purchase price of $36.24 to $36.88, a $0.64 increase. The new stop is then 8% below $36.88, or $33.93. Each blue cell is the trailing loss point, as the price increases.
   
   
   Fig. 4 PIP with an 8% trailing-loss.

7. Some things to notice on this spread sheet:
   • The trailing loss changes when the stock price exceeds a previous high since the stock was bought.
   • The trailing loss Never goes down. If the price decreases, the loss remains the same.
   • The current stop for NEM is higher than the initial purchase price.
   • AMI was kicked out on 08/06/03 at the stop level of $15.54. That money was then invested in another pick, SPIL.

8. What have we learned? A trailing stop-loss can be placed at some chosen level below the actual price. This trailing loss increases with the price, hugging the price trend but a comfortable distance away. Under no conditions is the stop-level ever reduced! So long as the trend is in place, normal price fluctuations will not trigger the stop. But, when a large enough decrease signifies the trend is in jeopardy, our stop will kick us out ahead of the fall. Should the price take off, our strategy will capture the large gains we so fervently hope for, as the strategy protects our profits. How close should the stop be to the price? Same question as the fixed percent stop-loss, same answers. We paper-trade the picks, trying repeated trials at different levels until the answer jumps out at us.

9. This concludes our study of exit strategies in this guidepost. We’ve now seen two strategies; a fixed stop level and a trailing stop level. Both strategies have advantages and disadvantages. The first “fixed stop” is simple and very easy to setup. It allows us to lose profits we’ve gained if we become distracted and lose control. The “trailing loss” takes more time and attention but protects profits gained. Which of these two sounds more attractive? A good exercise before the next lesson; paper-trade at least ten tickers of your choice through the week, using both stop-loss exit strategies. Compare the two as the week progresses to honestly say which feels more comfortable. We will cover other stop methods next week before we move to entries.

10. This week we’ll begin a study of price charts as a critical feature in our trading tool box. Technical Analysis (TA) is a study to understand messages in the price chart itself. That is, what does the price chart suggest about future price patterns? Can the chart predict future moves? Wouldn’t that be a boon to our trading account! Rather, it is all about probabilities and likelihoods. As with all probabilities, they suggest, they infer, they imply what might happen. There are many in the business who view “chart reading” akin to ouiji boards and star gazing. That is another decision we must make individually about our own “system.” Do not dismiss TA out-of-hand but learn with us why it is important to keep all the probabilities on our side.

11. Look at last weeks Main-pick performance to begin this venture into chart reading. Not a bad seven days, well ahead of the market. But the point here relates to the importance of looking at price charts as we learn to invest or trade.
    
    
    Fig. 5 WatchList for Main Picks on 8/15/03.

12. The best performer in this watchlist, CMOS, brought a healthy return in one short week. Lets turn to its price chart for some important lessons. The black marker on the chart shows the day of the pick (08/15/03), with its subsequent five trading-bars to 8/22/03. This chart includes only price and volume bars. The blue line on the volume window is a 90 day moving average of volume, helping us see the big-picture trends.
    
    
    Fig. 6 CMOS daily price chart on 8/22/03.

    LI>The price is in a general up-trend through the period shown on the chart. As the trend continues upward, there are retracements, or pullbacks, climbing higher in a stepping fashion. Chart patterns such as this are wonderful tools to use to find opportunities and to reduce risk. We will study in more detail in the next lesson how investor behavior shapes the chart patterns. The value in reading the chart patterns derives from the fact that people tend to behave in similar ways when faced with similar situations. Now fix the “daily” chart pattern in Fig. 5 in your mind, then jump to a weekly chart of the same ticker.

    
    
    Fig. 7 CMOS weekly price chart on 8/22/03.

13. The increasing price trend in the “daily” chart look less formidable in the “weekly” version. Point: When using price charts to understand the “character” of a market, always look at the chart on at least one other time frame. As well, look at the volume pattern to sense investor enthusiasm for the price action taking place. The blue moving-average volume-line provides a reference. Point: Nothing is good or bad, large or small, significant or insignificant, until we compare it to something! Remember this principle in all chart reading.

14. Now consider the performance on last weeks Breakout pick list. We will compare the price chart on both the best and the worst performers after one week.
    
    
    Fig. 8 WatchList for Breakout Picks on 8/15/03.
    
    
    Fig. 9 CYD daily price chart on 8/22/03.
    
    
    Fig. 10 CYD weekly price chart on 8/22/03.
    
    
    Fig. 11 WLDA daily price chart on 8/15/03, or what it looked like on the day of the pick.
    
    
    Fig. 12 WLDA daily price chart on 8/22/03, one week later.
    
    
    Fig. 13 WLDA weekly price chart on 8/22/03.

15. One more view of WLDA
    
    
    Fig. 14 WLDA daily price chart for one month on 8/22/03.

16. The charts shown in this guidepost have included only price and volume bars. We will study a host of indicators that can be added for a variety of reasons, helping the price chart whisper its messages. However, the most violated principle in all of technical analysis is to somehow believe the indicators are more important than the price pattern itself. The contrary is true, with price and volume alone reigning paramount in chart messages. In fact, all other indicators are derived from price and volume. That means indicators by their nature are “lagging” price and volume. They tell us what has happened. Price tells us what is happening. We will study the important role indicators play in TA and use them to our advantage. Remember, however, the importance of price and volume, no matter how dependent you may become on favorite indicators.

17. Next week, in addition to our last GP on stop-loss exits, we’ll begin to study why price patterns move up and down, why some stocks “roll,” and why some seem to just drift sideways. It is all about investor psychology which has remained pretty much the same since traders first bargained amongst themselves when time began.
    08-22-03 Pick Selection:

    Main Picks:
    ARM,ARTI,BLDP,BMHC,CBT,DIOD,HDWR,NSS,TKR,ZRAN
    Breakouts:
    ARA,CLE,HUB--B,INVX,MALL,MSS,PETC,PKI,SFCC,STCR
    QuickPicks:
    AAII,ADPT,AMSC,APCC,BELM,BLTI,CMTL,EPNY,KVHI,PXLW

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

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