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Rules of Investing

 

Every investor should have preset rules to follow in their investment decisions. There is no perfect formula that will guarantee success as unforeseen variables can affect the performance of a stock and the overall market. However, there are general rules and considerations that can enhance probabilities of success. 

 

General Factors to consider before you invest:

·         Health of the Overall Market (major indexes, sectors) 

·         Fundamentals of the Company     

·         Stage of the Stock (Basing, Advancing, Topping, Declining)

·         Technical Indicators     

 

 

Every investor should protect themselves with strict Buy / Sell Rules.

Adhere to those rules that make the most sense for your philosophy and be consistent in executing the decisions. Applying a methodology will help to manage the two most extreme emotions in the financial markets – greed and fear.  

 

 

Most stocks follow the general market’s trend:

Ø       Stocks tend to rise when NASDAQ, Russell 2000, S&P 500 and Dow Ind. move higher. 

  

Ø       Stocks tend to fall when the major indexes trade lower.

 

 

An Ideal Strategy is:

Ø       In a Bull Market, buy stocks as close to the pivot point (ideal buy price) as possible that are breaking out of solid bases on surging volume.
 

Ø       In a Bear Market, stay on the sideline in cash to avoid losses.  
 

 

#1 RULE:  PRESERVATION OF CAPITAL: USE STOP LOSS PROTECTION:

Ø       Sell stocks that fall 5% - 7% below your cost.  NO EXCEPTIONS

Ø       There will be times this stop-loss rule will exit you from your position and the stock then turns around and takes-off to the upside. These situations are the price one pays to protect insure against severe losses. 

 

 

CREATE A WATCH LIST:

·         Create and maintain a watch list of stocks that are sound in fundamental and technical considerations. This is your Target List.

 

Ø       On a fundamental basis, these companies should be superior to their peers as they are leaders in their industry with unique products and services.

 

Ø       Identify the strongest sectors and focus on the leading stocks within the sectors. Conversely, avoid laggard stocks in a leading groups.

 

Ø       Focus on stocks that form sound bases.

 

Ø       Identify stocks that are close to the pivot point.

 

Ø       Identify stocks that trade close to their highs in a declining market, as they tend to do well when the market rallies.

 

Ø       Keep the list fresh, adding and removing stocks as warranted.

 

 

 

CONSIDERATIONS FOR BUYING

·         Buy stocks at the right time:
 

Ø       Wait for the market to be in an up-trend. A healthy market is one of the most important influences on any stock. A key sign of a healthy market is when high-quality stocks emerge from solid bases and advance to new highs on unusually heavy volume.

 

Ø       The ideal time to buy a stock is when it emerges from a sound base accompanied by heavy volume. Buy as close to the pivot point (ideal purchase price) as possible. Focus on buying high-quality leading stocks within the strongest sectors.

 

Ø       Add to your position by averaging up, not down. A key to successful investing is to buy a stock on the way up (which makes no sense to investors that are determined to purchase bargains). You want to buy stocks that prove at an early stage from their base that they have the power to move higher. 

 

 

·         Indicators that signal the stock might be headed for higher prices:
 

Ø       Trading ABOVE the 50-day moving average.
  

Ø       Heavy Volume propels the stock price upward.

 

Ø       Rising Relative Strength (RSI).

 

Ø       Positive MACD (momentum indicator).

 

Ø       As the stock trends upward in a channel, volume should increase when the price rises, and volume should decrease when the price trends lower to test support.

 

Ø       When the stock successfully tests support within a channel rising upwards on heavy volume, each high is to be higher than previous high and each low to be a higher low than previous low.

 

 

 

 

CONSIDERATIONS FOR SELLING

·         Sell stocks at the right time:
 

Ø       Uncertain market climates and Bear Markets are when you want to be on the sideline in cash to avoid losses.

 

Ø       Sell when your stock falls 5% - 7% (or less) below your purchase price.

 

-   Sell when the price falls below support levels.

 

-   Sell when a stock falls below the 50-day moving average (dMA) on heavy volume and fails to recover above the 50-day line. This is a warning that something may not be right with the stock.

 

-   Sell when a stock falls below the 200-day moving average (dMA). If you have not already sold the stock fell below the 50dMA, or 100dMA, this is the “get out now” warning.

 

Ø       Sell if a stock falls for several days and does not rally back.

 

Ø       Sell if a stock advances then falls sharply retracing gains of the rally.

 

Ø       Consider taking profit if the stock makes new highs in later stage bases. If the stock is in a third or fourth stage base, the potential for gains is not as great as the gains made in an earlier stage (first and second) stage. Advances in later stage bases usually experience greater volatility and impose greater risk than advances in early stage bases.

 

Ø       Consider taking partial profits at 10%, 15% or 20% appreciation depending on overall circumstances of the stocks history, sector strength and general health of the market.

 

Ø       Consider taking profit with 5% - 10% gains if at any time situations with the stock or overall market climate become uncertain adding potential risk to your gain.

 

 

·         Indicators that signal the stock might be headed for lower prices:
 

Ø       Trading BELOW the 50 day moving average. 
 

Ø       Heavy Volume propels the stock price down.
 

Ø       Declining Relative Strength.
 

Ø       Negative MACD (momentum indicator).

 

Ø       Decreasing volume on market rallies and increasing volume on price declines provides insight that there is less excitement of buying and greater selling pressure.

 

Ø       When the stock tests support levels within a channel and falls below the support line on heavy volume, it is a signal the stock may be heading lower. Further confirmation is a series of lower highs and lower lows in price. 

 

 

  

GENERAL CONSIDERATIONS:

·         As the stock advances above your buy point, raise the floor of your stop-loss:
 

Ø       Do not allow gains to turn into losses. 
Example: You bought the stock at $20.00 and have a 7% stop-loss set at $18.60.

Your stock rises to $24.00. Raise your stop-loss to $22.32. Continue to raise this floor as your stock rises.

 

 

·         Early stages of market rallies are when the most and easiest monies are made:
 

Ø       Leading stocks tend to emerge from their bases prior to laggards.

 

Ø       Late stage rallying stocks tend to have lower relative strength ratings.

 

Ø       Avoid investing aggressively in the later stages of market rallies as odds of a correction are rising. 

 

 

·         Identify leading sectors and focus your Target List on leading stocks within the sector:
 

Ø       Leading stocks will offer greater gains and less risk than the laggards.

 

 

·         Avoid low-volume breakouts:
 

Ø       A stock that advances above the pivot point on low volume does not have institutional backing and may be poised for further basing or potentially a price reversal.

 

 

·         Avoid buying extended stocks:
 

Ø       Stocks that have rallied 10 - 15% or more above their pivot point typically pullback.
- Wait for pullbacks to occur for entry opportunities in up-trending stocks.

 

 

·         Avoid adding more shares to your position in a stock that is declining:
 

Ø       Some investors believe that when a stock declines lower from the initial purchase price that it is a good deal as it is cheaper and a bargain. This concept is flawed, as the risk is undetermined. Minor losses can quickly snowball into severe losses.

 

 

·         Avoid “cheap stocks”:
 

Ø       Focus on buying higher quality stocks selling at a minimum of $10 and higher.

 

Ø       A stock trading below $10.00 typically has low institutional participation and therefore provides for lighter volume and wild price swings.

 

Ø       A stock under $10.00 that is heavily institutionalized typically has fallen from higher levels to this juncture due to deterioration in fundamentals.

 

Ø       Stocks under $10.00 typically are in declining or basing patterns and the investor may have a long holding period. 

 

Ø       If you do consider to invest in a stock trading below $10.00, wait for the indicators to signal when the proper time to buy might be:

- Emerging from a sound base

- Trading close to the Pivot Point

- Heavy Volume accompanying the rise in price

- Trading Above the 50-dMA

- Rising Relative Strength

- Positive MACD momentum

- Positive fundamentals / news / earnings

- Strength of the sector in which the stock resides

 

 

·         Avoid using redundant indicators:
Example: MACD and stochastic oscillators both measure
momentum.
 
 

Ø       Select indicators that measure different phenomena such as relative strength, momentum and trading volume. Use 1 indicator for each.   

 

 

·         Avoid emotional attachment to a stock:
 

Ø       You may like a product or service the company offers but “it is just a stock.”  It can help you gain or lose money.

 

Ø       Never allow emotions to drive your buy and sell decisions.

 

Ø       Greed and Fear can destroy your portfolio.

 

 

·         Avoid Short-Selling:
 

Ø       Selling Short - means you sell shares borrowed from a broker as you are anticipating the stock will decline in price. Your goal is to buy the stock back at a lower level with the difference in price being your profit.  In a traditional buy and sell, you can only lose the amount of monies invested. If the stock goes to $0.00, your loss is limited the initial investment. With short-selling, the risk is unlimited. When the stock rises, you need to cover or “close the short” buying it back at a higher price. Climactic price gains in a stock driven by unforeseen factors / news stories can be devastating.

 

Ø       Short-Selling is part of the daily strategies within the markets and should only be applied by professional investors that can manage the associated risks.

 

 

·         Caution when a stock has failed to breakout on several attempts:
 

Ø       A stock that has surged above the pivot point on heavy volume and then pulls back to the pivot point in the same day is signaling “it is not the right time” as indicators may not be as positive as you would like them to be.

 

 

·         Caution when a stock and / or the overall market makes new highs on weak volume:
 

Ø       There is usually no problem when a stock edges higher for a few days on lighter volume. However, if a week or more passes with light volume up days, it suggests there is not much institutional demand for the stock.

 

  

·         Caution - climax runs usually are warning signals that the stock may be at a peak:
 

Ø       Institutional demand can drive the price up or institutions can sell shares to cause the stock to nose dive. When a stock has had a lengthy advance then suddenly spikes up 30% - 50% (or more) on heavy volume, the phrase “what goes up must come down” should be applied. You do not want to be buying in at the peak of what might be the top and final climax of the run.  

 

 

·         Caution when a stock advances and the sector does not confirm the move:
 

Ø       You might own a good performing stock within a sector but if the overall sector is weak or declining, the potential gains for your stock may be limited and the risk factor is higher. Ideally, you want to own the leading stock in an advancing sector. 

 

 

·         Caution when leaders in a sector begin to breakdown:
 

Ø       When the leaders in a sector begin to deteriorate in terms of price performance and technical indicator strength, it is likely the stock you own in that sector will likely do the same. Monitor carefully with stop-loss protection.

 

 

·         Caution when a stock makes new highs on lighter than average daily volume:
 

Ø       New highs on lighter volume signals the stock is having a tough time attracting new buyers.

 

 

·         View stock historical patterns that go back a number of years to see how the stock has rallied or sold off as it reached certain price levels:
 

Ø       Review a 3 - 5 year chart of a stock for the big picture insight to major support, resistance and trend channels of the stock. This provides for an understanding of the important, historical trends and key price levels.

 

 

·         Study past trades to analyze your winning and losing positions:
 

Ø       Take the time to understanding factors that contributed to wins and losses as this can help you to adjust future buy / sell strategies. There is a constant learning curve to the study of the market.

 

 

·         Do Not Chase News Headlines:
 

Ø       Instead of chasing news headlines or tips from friends, focus on solid growth stocks breaking out of sound bases. Identify sound chart patterns and stocks trending upward with institutional buying. 

 

 

·         Take An Investment Break:
 

Ø       When uncertain, stand aside. It is best to have a clear understanding of the mood, sentiment and overall health of the market prior to making an investment decision. 

 

 

·         Block Out Opinions Of Others:
 

Ø       Opinions are everywhere. If you let them change your mind, it will always be changing. Rely on sound strategies that identify defined buy / sell price points.  

 

 

 

REVIEW PAST TRADES TO IMPROVE PERFORMANCE:

There is no perfect formula that will guarantee successful investments all the time. However, you can be right on less than half your trades and still be a successful investor as long as you keep your losses small, let the winners ride and employ sound sell rules to secure profits.

 

Every investor makes mistakes. The key is to figure out where you went wrong, and then correct the bad habit. 

 

·         Learn From Your Mistakes:
 

Ø       Maintain a trading log of your investments.
 

Ø       After a few months, review past trades to see if you bought or sold at the right time.
 

Ø       Utilize charts to view the picture of the stock history identifying the buy & sell points.

 

 

A few considerations to review of your trading activity:

1.      Did you sell a stock too early and then the stock advanced for huge gains?

 

2.      Did not implement a 5% - 7% stop-loss and stock fell producing a large loss in your portfolio?

 

3.      Did you invest during a market downturn and experienced repeated losses?

 

4.      Did you miss sell signals and then see your profit in a stock evaporate?

 

5.      Did you buy below the pivot point and sold before the breakout?

 

 

As the above scenarios might be applicable to your portfolio, a few considerations to enhance future performance might be as follows:

 

1.      Hold the stock through mild corrections unless it presents clear sell signals or the market deteriorates.

 

2.      It is imperative to implement loss-cutting rules.

 

3.      Go to cash when the market flashes a series of selling days.

 

4.      Monitor your stock’s price & volume action daily for trouble signs.

 

5.      Wait until a stock clears its base before committing investment.

 

 

 

 

SUMMARY:

For many people, it seems prudent to believe that remaining invested through good and bad markets is a sound investment philosophy. This strategy can at times, bring tragic results. There are many bear markets that are not mild, and some are devastating for an investor that remains dedicated to the buy & hold philosophy. As discussed in this publication, the 4 stages of a stock cycle are BASING, ADVANCING, TOPPING and DECLINING. Hopefully, the knowledge gained from the material discussed in these chapters will enhance the investor to implement a flexible investment strategy where buys and sells are based upon the health of the market coupled with technical indicators as viewed on charts.   



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