Strategy

Subject to change at any moment

Buying | Selling

Not to put too fine a point on it, I've found it much harder to make money in the market this year.

• There are far fewer candidates to chose from now compared to last year. A year ago, the market was just bottoming and there were many beaten-down companies with share prices in the $5-$8 range. My screens now turn up few in that range and those that do turn up are often not very strong candidates. That is, the charts show excessive volatility, many gaps, or price jumps too-far too-fast.

• The market is consolidating after finishing last year with a strong upward trend. Combine that consolidation with decidedly mixed news (a strengthening economy but a weak dollar and no jobs growth), and the result seems to be increased volatility. Trends seem to be shorter-lived, rather than sustained.

Buying

Buy stocks in the $5–$15 range. While I prefer to buy stocks at the lower end of that range ($5-$8), I will go higher to find strong candidates.

Buy stocks beginning or sustaining strong upward movement. Two screens are useful for identifying candidates:

  • Stocks in new uptrend (ADX). This screen identifies stocks for which the value of ADX has just moved above 20 and with +DI above -DI. (Free scan at stockcharts.com)
  • Steady climbers. This screen identifies stocks with an ADX value above 40 and with an RSI value above 70. (Scan in Advanced Analyzer, a tool for Ameritrade investors)

The difference between these two scans is that the first catches stocks when they just begin to move, whereas the second catches stocks in a sustained upward trend.

Buy an initial lot of 1000 shares. If the stock is priced above $8/share, then reduce the number of shares to a maximum investment of $8000.

Pile onto winners. If the price of the stock closes 5% over the original price, buy an additional 500 shares (or a maximum of $4000). If the price rises another 5% (10% over the original price), buy another 500 shares (or a maximum of $4000).

Buying the two additional lots has the effect of raising the average price per share by a maximum of 4%. If the price never rises that much, no additional investment is made.

Avoid buying just before earnings are reported. The Expectations game makes this a complete crap shoot. I've found that Yahoo Finance has the best calendar of earnings dates (biz.yahoo.com)

Selling

Jettison the losers. Sell if price drops more than 8% below what I paid. The reason for this rule is to protect capital.

William O'Neill pointed out in an Ameritrade webcast that being right once will make up for being wrong twice:
Start with an investment of $5000
Buy $5000. Lose 8%. Leaves $4600. Reinvest what's left.
Buy $4600. Lose 8%. Leaves $4232. Reinvest what's left.
Buy $4232. Gain 20%. End up with $5078, which is more than you started with.

I've always had this rule, but haven't applied it consistently. I need to. Hoping that a stock's price will go back up easily leads to holding on too long and losing even more.

Apply the net proceeds from the sale to buying additional shares of the best-performing stock in the portfolio. The reason is simple: put the money on the winner.

Systematically (every week) sell the weakest performing stock in the portfolio. The reason for this is to avoid investing money where it's not getting a good return.

Use the proceeds from the sale to increase the position in a stronger stock. That is, keep the money invested where it gets the greatest return.

Sell half of shares on signs of reversal.

  • A bearish candlestick pattern
  • Price falls below price of any additional buys (after the initial buy)
  • Gap down on heavy volume
  • Consecutive down days with increasing volume
  • +DI line crosses below the -DI line (ADX)

Close position on signs of peaking or exhaustion (a "climax top").

hanging man
Hanging-man
long-legged doji
Long-legged Doji
  • Price rises more than 25% in a week
  • Gap up/down combined with wide daily range and narrowly separated open/close prices ("hanging man" or "long-legged Doji" candlestick pattern)
  • Price falls below 50-day moving average for more than a day or two