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us stock market, trend trading stock
Begin Part 2 of 3
SUBSCRIBER QUESTIONS
Q: As a practical matter, can you explain how you use stops as you define them? Also, how stops vs. stop limits work best when they carry over to the next day?
A: Stop losses are not perfect, but they are the best thing you can do to protect your gains other than watching the market closely or buying protective puts on long stock positions. A stop loss is designed to automatically trigger a sale of a security when that security hits a target price. You can place stops on NYSE stocks, and usually Nasdaq stocks, though if things get volatile, market makers may not take stop orders on Nasdaq stocks.
This works fine when the stock or option is gradually falling: when the stock dips to the target price and a trade is made, you are taken out. Problem is, stop losses (as opposed to stop limit orders) do not do any good when you need them the most, i.e., when a stock drops catastrophically on bad news or for some other reason. When that happens, the stock price can gap below your stop loss price. When that happens, your stop loss order then becomes a market order and you are taken out at the price of the next trade on the stock. In other words, if a stock is trading at 40 and you have a stop at 37, if the stock gaps down to 33, you are taken out at 33 if the stock trades there. Not what you had in mind. Moreover, how many times have you seen a stock gap down and then bounce back up above your stop loss order price? That is really frustrating. You are trying to be responsible, and you get hammered for it. If you were out for coffee when the news hit and you did not have a stop loss order in, you would have been okay, or at least able to get out at a better price because you would not have been taken out by that stop loss order.
Stop limits are different in that the price you set is the price you want to be taken out at, i.e., a limit order and not a market order. If the stock gaps below that price, your order is not converted to a market order, but is a limit order at the target price. If the stock then rises back to the stop limit price and trades, you are hit at that price. Again, not the perfect solution, but it keeps you from being taken out at the bottom which is what a stop loss order pretty much guarantees when there is a large gap down in a stock. And let's face it, when you need a stop loss the most is the situation where a catastrophic drop occurs. If we have some bad news overnight on our stock or on the market as a whole, often we will pull our stop orders to avoid being taken out at the session low or at some point we decide is not the best place. That requires us to watch the stock that day, but it is our money at stake, so we do what we must.
Nothing beats watching a stock, but even that will not save you from a gap down - - that is a fact of life. You can buy protective puts, but you have to anticipate bad news. It can be done (e.g., earnings time), but you have to come out of pocket with cash, and that raises your breakeven point. What we prefer is to anticipate when bad times are ahead (a market top or topping signs in our stock as taught in the seminars), and be ready to act. The market or the stock usually gives us those signs ahead of time, though as noted, bad news when the market is closed is something you cannot avoid. We can usually close positions quickly and take the other side of the fence to capture gains on the downside. In short, nothing is perfect to preserve your capital when unexpected bad news hits your stock.
Given that, in setting stops to protect profits in normal market volatility, we look for support levels. If a support line is strong (solid breakout, the stock spend a lot of time at that level), the stock should hold above that level. It could trade below it intra-day, however, and that adds to the art of setting stops. If support is close at hand, depending upon what type of stock we are playing (volatile or more staid blue chip), we will pick a spot at some point below support, looking at the intra-day lows the stock hit when it traded around that support level to determine our stop position.
If a stock has raced up well above any support as we have seen lately, setting a stop at support could mean a loss of $20-$30 points before support is hit on selling. If we have that much profit, why would we want to lose it all and still get taken out if our stop was hit? Much depends upon if this is a long term hold or a short term investment where we are playing a specific trendline move or are trying to capture the gain on a breakout move (perhaps using options). Most stocks breakout and then test the breakout; after that they move up their short term moving averages, bouncing higher and then testing them. They do this 4 to 5 times and then test lower. What is the move we are playing? That is what we have to know so we can put our sell points in such that they match the investment we are making. Use the trendlines and support as your guide. When we have a big run in a stock and it is showing signs of topping, we will start paying closer attention- - common sense. We will also determine if we want to ride out a pullback or keep our profit and get back in when the stock starts back up. This is the trickiest part of stops. If you set your stops too close on some huge movers in the 1990's, you would have sold out too soon.
Once we get a significant amount of profit built in on a long term hold, we usually let it alone if we think it is going higher. Use long term trendlines as your guide along with price/volume action. We will sell calls against the position when its starts a pullback, but we don't want to lose the stock, so we don't use a stop. We may ultimately want to sell if it breaks a trendline, but we have time to make that decision and can place the sell order at that time.
If we have a short term play we are trying to ride until it tops, if no support is close at hand, we set stops at a level where we are able to keep a good chunk of our profit. It is then incumbent upon us to get back in when the stock improves and is in a buy position again.
THE PLAYS: LMT lunged higher again today as volume really surged. We covered SANG back on 9-27 on the breakout, and it subsequently pulled back beautifully to support until today when it broke out on huge volume. This one remains a buy up to 20.15 on this strong move; volume was huge so aggressive players can look at riding it until it shows signs of topping. SVU was dropped over the weekend to make room, but that one broke out today as volume surged. Remains a buy up to 23.50. For both of these stocks, look at entry points on any possible early morning weakness. ISIP still looks good and is holding support above its 10 day MVA. Buy point is over 18.76 on strong volume (still below average Monday).
Note for reading plays: A "prior high" refers to the high at the start of a base.
All prices are current as of the close of trading Monday.
Best Plays:
1) CAH: Pulling back in a handle.
2) KLAC: Looking for a rally in the sector.
3) TERN: Moving up after testing the breakout.
4) VZ: Tightening up nicely on low volume.
5) MMC: Looking for a bounce.
6) DORL: Still a good pattern.
NEW PLAYS: We are covering the SOX index in that section under Continued Plays.
CAH (Cardinal Health--$73.95; -0.69; optionable): Drugs Wholesale
http://biz.yahoo.com/p/c/cah.html
STATUS: Pulling back in the handle to a double bottom as volume decreases, reaching Monday 880,600 (avg. 1.38 million). The stock pulled back and closed above some support at the 73.50 range and may hold here instead of engaging in a test of the 10 day MVA (73.12) before it is ready to head back up. Looking for a breakout over the handle high at 75.14. CAH shows decent money flow and high relative strength. Target: 90
BUY POINT: Breakout: 75.27 on minimum breakout volume of 2 million. Stop: 71.71 (just under the 50 day MVA).
POSITION: Stock and/or December $70 calls to buy (CAH LN).
|mkttt|mktss|Pivot=75.27 Dbl Btm w/handle Tgt vol=2M Tgt $=90 Stop=71.71
BEC (Beckman Coulter--$45.11; +0.83; optionable): Scient & Tech Instruments
http://biz.yahoo.com/p/b/bec.html
STATUS: Made a move out of a lateral consolidation that formed over the last several days, off a nice little run up from the 200 day MVA (40 range). That test of support happened after BEC sold off early September. Volume has been at or below average overall in the current pattern, and was indeed lower Monday (to 230,600; avg. 238,000) on the move out and above resistance at the pattern high of 45.06. We are looking for increasing volume to support a continued breakout. Shows good money flow, and relative strength is breaking out. Target: 54
BUY POINT: Breakout: 45.19 on minimum breakout volume of 321,300. Stop: 42.75 (below today's intraday low that tested just under the 50 day MVA, 43.72).
POSITION: Stock and/or November $40 calls to buy (BEC KH).
|mkttt|mktss|Pivot=45.19 Lateral consolidation Tgt vol=321K Tgt $=54 Stop=42.75
KLAC (Kla-Tencor--$36.36; +2.95; optionable): Chip Equipment
http://biz.yahoo.com/p/k/klac.html
STATUS: Moved over the 18 day MVA (36.13) on a strong shot of volume (10.2 million; avg. 8.1 million). Looking for a trade up to the range of the 50 day MVA (42.76), with possible topping just lower at 42, a nice little run given continued strength in the sector. With the MCHP news that its inventory correction is complete, we may just get it. Should the stock gap higher initially, look for a move back to test today's closing price, or the 18 day MVA, looking at positions on a move up from either.
BUY POINT: From the 36 range: Over 36.85 (intraday high) on continued strong volume. Stop: 34.50
POSITION: Stock and/or December $30 calls to buy (KCQ LF).
|mkttt|mktss|Pivot=36.85 Momentum Tgt vol=10.3M+ Tgt $=42 Stop=34.50
Back On:
TERN (Terayon--$8.93; +0.79; optionable): Telecom
http://biz.yahoo.com/p/t/tern.html
STATUS: That didn't take long. TERN took 2 days to test the breakout from its saucer/cup with handle base, then headed out on stronger volume, just making it through the breakout high resistance at 8.87. Look for a continued move up from here; stocks often post as strong or stronger gains after testing the breakout. Great buying. Target: 11
BUY POINT: Riding positions taken on the breakout (7.68 buy poin). From here: 8.95 on stronger volume (up to 1.39 million Monday; avg. 994,000). Stop: 8.32
POSITION: Stock and/or November or January $7.50 calls to buy (TUN KU or AU).
|mkttt|Pivot=8.95 Test BO Tgt vol=1.4M+ Tgt $=11 Stop=8.32
From the weekend:
PDG (Placer Dome--$12.69; -0.30; optionable): Metals & Mining.
http://biz.yahoo.com/p/p/pdg.html
STATUS: Tried to move higher Monday but pulled back on lower volume to test the 18 day MVA on the low of 12.50 before bouncing back to rest on its 10 day MVA. The stock is pulling into a lower volume handle-type consolidation over the May highs (at 12.50), and Friday had made a nice move up from the 18 day on strong volume. From there we were looking for a breakout but the lower volume didn't support a continued move. Looking for a bounce on again rising volume (down to 979,300; avg.1.2 million). Target is 15.50 on a breakout over 13.49, the September high.
BUY POINT: Aggressive: 12.85 on a bounce from the 10 day MVA as volume rises.
Breakout: 13.61 on minimum breakout volume of 1.6 million. Stop: 12.66
POSITION: Stock and/or January $12.50 calls to buy (PDG AV).
VZ (Verizon Communications--$54.49; +0.03; optionable): Telecommunications.
http://biz.yahoo.com/p/v/vz.html
STATUS: In a large base that started fall of 1999 (highs at 69.50) and currently in a big ascending wedge that formed since mid-2000. Recently the stock has hit up at resistance at the May and July highs around 57, and this month has not been able to move over 56. The last 2 days the stock has again pulled back, showing 2 consecutive dojis as volume drops back nicely below average (3.46 million; avg. 5.3 million). Holding at support (just above 54), we are looking for a move up from here on strong volume. Good money flow, high relative strength. Target: 65
BUY POINT: Aggressive: A bounce over 56 on increased volume. Stop: 52.50. Breakout: 57.52 on volume of 8 million or better. Stop: 54.
POSITIONS: Aggressive: Stock and/or January $50 calls to buy (VZ AJ). Breakout: Stock and/or January $55 calls to buy (VZ AK).
MMC (Marsh & Mclennan--$100.95; -2.00; optionable): Insurance Brokers
http://biz.yahoo.com/p/m/mmc.html
STATUS: Pulling back from last week's super trend reversal move over the 200 day MVA and the down trendline that connects Dec/May/June highs. The stock closed at the 200 day MVA as volume continued to fall back (to 1.14 million; avg. 973,681), the lows of the last three days testing around 100 (today's was down to 99.20). Look for a hold at support and bounce back up. Initial target: the October high and range of the down trendline at 105.50. Target on a breakout: 111
BUY POINT: Aggressive: 101.25 on volume of 1.2 million or higher. Stop: 99.50 Breakout: 105.63 on volume of 1.8 million. Stop: 100
POSITION: Stock and/or January $95 calls to buy (MMC AS).
ARG (Airgas--$13.49; -0.01; optionable): Industrial Equipmt Wholesale
http://biz.yahoo.com/p/a/arg.html
STATUS: After the great 2000 uptrend to 14.48 then correction to the 200 day MVA (10), ARG is pulling back from a run up to 13.96. It is showing its third doji in a gentle pullback on low volume (116,400; just up but still well below the average of 198,000). The low tapped support at the 10 day MVA (13.09) and the 18 day MVA is at 12.94. Looking for a hold there after a continued pullback, but the stock can grab support at the 13.25 range. Trying to set up the right shoulder in a reverse head and shoulders pattern.
Initial target: 17
BUY POINT: Aggressive: 13.75 (over 13.70, a price hit 8 times since mid-August) on volume of 199,000 or higher. Stop: 12.79 (just below the 18 day MVA, 12.87).
POSITION: Stock and/or January $10 calls to buy (ARG AB; 35 open interests).
DME (Dime Bancorp--$38.95; -0.75; optionable): Savings & Loan
http://biz.yahoo.com/p/d/dme.html
STATUS: Not a great day for bank stocks, and DME moved below its 50 day MVA (39.12); volume was lower to be sure, at 608,300 (avg. 866,000) but we like the lower volume, giving the stock a chance to hold support at or above the October lows (38.55). We will look for a hold there; the stock is in the handle to a double bottom and Friday made a solid move up that today was thwarted. Great money flow and buying. Target: 48.
BUY POINT: 40.37 on minimum breakout volume of 1.3 million. Stop: 37.70. A buy on the breakout up to 42.39.
POSITION: Stock and/or December $35 calls to buy (DME LG).
DORL (Doral Financial--$38.15; -0.36; optionable): REIT
http://biz.yahoo.com/p/d/dorl.html
STATUS: Formed a small ascending wedge/pennant as it consolidates off a nice run up from the 200 day MVA (30). Resistance looks tough at the 39.30 range, but with the nicely decreasing volume (down to 186,600; avg. 522,045), if DORL holds support here, it has a good chance of making the breakout over it. Showed a doji after testing the 18 day MVA on the low of 36.30 (a nice intraday recovery back over 38 level support). Huge money flow. Target: 47
BUY POINT: Breakout: 39.57 on minimum breakout volume of 666,000. Stop: 36.80 (just under the 10 day MVA, 37.02).
POSITION: Stock and/or November $35 calls to buy (QDL KG).
End Part 2 of 3
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us stock market
trend trading stock
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