Friday, May 25, 2007

Excerpt from today's newsletter

We had one trigger on Friday and one loss as CMG just triggered the stop before reversing and running for the rest of the day.

CMG was a bit of a heartbreaker. She had been on our radar for days but when it was time to trigger, she had very little volume. This was for us what we call a "conviction trade" in that once she broke the base, even though volume was very light, we "knew" she would go. However, the volume was so light that the risk was quite high in case she reversed. How did we deal with the trade? We took a small position with fills around 83-83.1, with stop at ANY reversal back towards the base (82.7-82.8). If you think that a stock will go and the pattern is very good but you think that the volume might come in after the actual break (which unfortunately is relatively common) then maintain the same risk by lowering your position size, but give it a shot. Even a 1/3 or 1/4 position can give you profits and more importantly, it will give you practice and experience in the base and break pattern.

Should you have entered at 83.5? No -- the base was 82.8 and she was almost 1% away by that time. The only place to have bought the stock was on the breaking bar with fills around 83 (and thus 30 cent stop). Remember, it's not the alert price that's important, it's the break of the base UNDER the alert price that one has to buy (unless the set-up actually is AT the alert price and not under). The breaking bar of the base is the most important part of our system.

There are multiple advantages to buying the break of the base instead of waiting for the actual alert price, an important one being that your stop is naturally lower. Thus, even though the stock fumbles around the number (which CMG, for example, did, and which technically triggered our 0.3% stop) you still can stay in and wait for the stock to consolidate without going negative (even though we always recommend selling at least a partial into the break-out). In good markets it often is advisable (as we write in the How to Use our Services) to sell 1/3 at 1%, 1/3 at 2% and either sellf rest into 3%, end of day, or make it a partial swing position by holding overnight (of course always know the earnings dates of your stock).
Remember, you don't always have to buy 2000 + shares of a stock to make money. Let's say you bought as we did at 83 (point A), with a stop on any reversal, but since the base was 82.7, that was the number that you believed would be your first fill, even if you tried to exit when the stock was at 82.9. At this stage of your trading career, you are only risking $200 per trade (something we recommend to new traders). Thus, you would have, for example 30-40 cent risk, which means you could buy around 600 shares in a gorgeous set-up but with miserable volume (if the volume had been higher, you could assume a tighter stop with less slippage). Thankfully she doesn't reverse and you sell first 1/3 of your position at 83.7 ($140 profit minus commission) at point B. You sell this first 1/3 to lock in some profits; we always sell partial into the break-out point if the stock is vertical by the time she hits it (and she was) and if we are wary (and we were because of the lack of volume).

Now you move your stop up to break-even and well above the base at 83 (point A) for the remaining 2/3 of the position (400 shares). The stock consolidates but you weather the storm easily since she doesn't come back to your stop (and you knew she would mess around the number since she's a NYSE stock with still mediocre volume). The stock breaks out into its second phase and you sell 1/3 at 85 ($400 profit minus commissions) at point C. You move up your stop for the last 1/3 of the position to 84.4 which represents the secondary base at point D. You can sell your last third at point E or hold overnight. Let's say you decided to liquidate the rest of the position because she still did not have great volume and you don't feel comfortable holding overnight. You sell your last 200 shares at 86 for another $600 profit. Therefore, you only bought 600 shares, with an initial risk of $200. Your profit, even considering how early you sold the first 1/3 of the position, was $1140 minus commissions: that's just under 6 times your initial risk.

Of course they don't always work out this well, but if you love the pattern, and if you have conviction but the ducks just haven't lined up (for example, missing volume) then take a shot, but a reduced shot. We're always telling you not to be trigger-happy, but sometimes it's probably just as important to remind you not to be trigger-shy, especially on "conviction trades".