Newsletter
October 29, 2005
How to Take a Loss
Market & Sector Review
This Week's Economic Reports
How to Take a Loss
Humans are risk averse. We don't like losses, and we'll do almost anything to avoid taking them. Losses are painful, and there's a strong human need to seek out pleasure and avoid pain. Traders tend to come up with many ways of denying they have a loss, such as holding on to a losing trade and hoping it will turn around, or keeping losses on paper to avoid acknowledging them. However, you will trade more effectively and profitably if you can take losses as quickly as possible, move on and make a new trade. In his book, "The Disciplined Trader," Mark Douglas suggests that you close out losing trades immediately, the instant you perceive that a trade is a loser. The best way to do this is to have a clearly defined trading plan where you predefine where you will enter and exit a trade. Once you have a clearly defined plan, you can execute the trade without hesitation. There is nothing to consider, weigh, or judge and consequently nothing to tempt you to hesitate and be consumed with self-doubt.
The best way to take a loss is to anticipate it. If you go into a trade expecting that it may be a loser (and you always should), you won't be as bothered should the trade go against your expectations. If, you try to avoid considering the possibility of a loss, you'll become extremely frustrated when you are in the midst of a losing trade. Accept the fact that losses are the norm and not the exception.
Define your potential losses before you enter any trade. Define your possible loss, or risk, in comparison to your possible reward, or profit. Don't take losing personally! Traders who put their self-esteem on the line with their money are especially vulnerable to strong, unpleasant emotions when they lose. Take a more carefree approach, and think, "It is not personal; it isn't a big deal in the end," then you will be able to accept a loss and take quick, decisive action.
Taking a loss is a fact of trading. If you trade to make profits, you will face many more losing trades than winners. Because you lose more than you win, doesn't mean that you won't trade profitably over the long run. The fact that you lose trades is not an issue. The issue is how you cope with losses. If you view them as nothing more than a minor setback, you'll get back up and make trade after trade in order to come out of it. If you are stunned and disappointed, you'll actually give the losing trade more significance than it deserves.. So practice taking losses effortlessly. You'll trade more profitably in the long run.
Market & Sector Review
Last week's letter, Waveslider's dissertation "Using Relative Strength Readings for Stock and Index Selection" received accolades and questions, which is quite normal with such a diverse group as we have here. He has graciously agreed to write a step by step approach in a hypothetical example which we will hopefully publish next week. In the interim and in view of the questions received this week, in lieu of a market commentary, I will review relative strength and the various readings of relative strength that are available to you on this site and in this newsletter for your research. Personally I believe relative strength analysis is the single most important tool in the technician's toolbox. Instead of worrying and analyzing the major averages alone and what "The Market" is about to do, analyze groups and sectors to determine exactly where the strength and weaknesses are. You will be in a much better position to take advantage of great opportunities when they arise. There are two old market cliché's that you need to be aware of and apply here: 1) "It is not a stock market. It is a market of stocks" and 2) "There is always a bull market somewhere."
Momentum investing is characterized by identifying stocks displaying strong relative strength against a broad market index. Changes in relative strength are extremely important and as technical analysts it is strongly recommended that you get used to relative strength analysis. The exact components of relative analysis you will utilize will depend upon your trading time frame. For example if you are a longer term oriented investor and a stock has underperformed for a long period, but then turns up visa vie the broad market, you need to be aware, as this may be presenting a unique opportunity. Conversely when an outperforming stock begins to show relative weakness this is an early indication the move may be in its ending phase. Again it depends upon your trading time frame.
What is unique about this site is we report each evening changes in relative strength, first by index, group, and ETF, but then again by each individual stock. Relative Strength simply stated is the price of a stock divided by the price of a broad market index, i.e. GE/NYSE or IIX (Internet Index)/ NYSE and also against its sector or group. To be bullish you want to see a rising line. Keep in mind this line is a measurement against a broad or sector index average, your stock or group's relative strength line can be rising, even if that stock or group is declining. If your stock is declining but the relative strength line is rising, it simply means your stock is not declining as much as the broad market, an early sign of a potential leader in the next rally phase.
As an example, since September, MG-852 (Internet Information Providers) has been one of the stronger groups in the market thanks in part to Google's spectacular advance but there are others. If you were long the stronger stocks in this group during the recent "market decline" you might be amazed at the fact these stocks not only performed better that "The Market" they advanced in the face of overall bearish market conditions, in the major averages. First a chart of MG-852 with raw relative strength and a 21-day moving average plotted underneath.
Two ways for shorter term traders to use this line is: 1) simple trend lines applied to the relative strength window. Notice for instance the trend lines in the chart above. The trend-line break in late March was a good precursor of the impending rally. The breaking of the up-trend line was a good precursor to the last break before the down trend-line break led to the big rally; and 2) divergence analysis, notice that in the high point in June was also a high point in relative strength as well, however on the first then the second test of those highs in late June and mid July were accompanied by respective lower readings in the raw relative strength number indicating weakness against the general market.
In the various reports are groups, ETF's, and indices ranked against one another as to relative strength over 6 months and 12 months. This is simply a rate-of-change of relative strength over the corresponding period. For those that read IBD (Investors Business Daily) their relative strength rankings are based upon a 6-month rate-of-change or the strongest over the last 6 months. In a bull market phase the strongest in relative strength over the last 6 months and 12 months will often continue to lead the market higher. If you buy these stocks you will not be buying anywhere near the lows but in all probability they will still have plenty of room. Let's take a look at the same chart with both the raw relative strength and a 6 month rate-of-change in relative strength shown.
Looking at the above charts it is almost self explanatory just when this group should have been in the forefront of your thinking for potential purchases. However, instead of looking through 525 charts each night we have put together reports which will help you easily sort through without looking at a single chart until certain criteria pop out at you. The reports show a ranking of relative strength over a period of 6 months and 12 months. In other words all groups (or indices or ETF's) are ranked from 1 to 209 in the case of groups, 1 to 128 in the case of indices, and 1 to 188 in the case of ETF's, 1 being the strongest against the others ranked down to the weakest. There respective changes from 2 weeks and 1 month ago are also displayed so you can easily see the changes.
The above picture is from this weekends report sorted by 6-month relative strength rank. Notice that of all 209 groups MG852 Ranks 4th and is continuing to improve both in terms of 6-month and 12-month relative strength. You might ask, Bill that's nice but don't you think its too late now? Perhaps but here is what is interesting, in the September 10 Newsletter and then again on 9/17, 9/24, 10/1, and 10/8 this group appeared in the 10 most improved in relative strength for the previous week. Now scroll back up this page and notice the position of this group average on those dates. Plenty of time to make a move, if it fit your style and other criteria and be long.
Now for the next step, lets take a look at the stocks contained in this group. You do this by clicking on the link above either group report (Search for stocks within a group) and then key in the group number, in this case 852.
As you can see this group is not being driven by Google alone, although Google seems to get all the media attention. While the data for Waveslider's presentation is there for each stock, keep in mind it is against the NYSE index and not MG852. We are working towards bringing the same kind of information to you but better in this scan and that would be each of these stocks relative strength against there group or index. The idea is while many of these may be outperforming the market, they may not be outperforming their group piers. Since I have not as yet spoken to my programmer I have no idea at this point how big a project this will be. You notice there is a link to get a chart in each row, this link takes you to StockCharts.com, which has an indicator they call price relative that you can use. While they do not use the Media General groups for this example we will compare some of the above stocks against IIX - IW-Internet index so you can see what we are driving at.
This is basically a four step process that once you practice and understand will make your trading a great deal more profitable. Let others worry about the S&P-500, you follow the inflows and outflows.
- Start with the largest changes report each weekend (below).
- Look through the relative strength tables on ETF’s, Indices, and Groups, notice changes from 2 weeks ago and one month ago, select a few to look at further.
- Look through the component stocks, now also available on many indices as well as groups
- Check the component stocks relative strength not only against the broad market but also against their respective group or index average to find the strongest and/or the weakest.
Now that you have potential candidates apply your favorite signals to time your entry and exit knowing you'll be with some of the strongest and/or weakest stocks in the market.
I hope I have explained this to everyone's understanding but if not please do feel free to ask questions. Remember there is only 1 dumb question ' The one that wasn't asked!
This Week's Economic Reports
Have A Great Week!
Bill
Disclaimer: Trading in securities, of any type, may not be suitable for all individuals. The contents of this newsletter are not a solicitation to buy or sell securities. The opinions expressed are solely that of the author. You must do your own research, contact your own financial advisor for suitability of any investments. Data gathered is from sources believed to be reliable, but NO guarantee as to their accuracy is made.
|
|
