The best advice I can give to a new trader is to look for stocks moving sideways. That might sound strange coming from a trend trader. But the key is how a stock emerges from a sideways period that will tell you everything you need to know to buy or sell. The sideways movement assures that the stock in question is not overbought or due for a correction. It shows that the current price range is an area of support and as long as the stock is above the lows of the range, the risk/reward is tipped in your favor. Almost every one of my big winning positions have come from long-term sideways bases that resolve to the upside.
Ideally these sideways trends occur at multi-year or all-time highs. This shows an unwillingness for traders and investors alike to sell the stock. They are confident in their positions and do not want to sell. This tight supply is what creates the breakout momentum as those looking to buy have to pay up to get in.
I like a base to be at least 6 months, but preferably a 1-year sideways trend gives the most upside potential. Moves from bases this size can be spectacular.
Thriving in the market doesn't come from making wild moves, but rather from managing risk and being consistent. The beauty of a sideways trading range (consolidation) is that it defines the risk perfectly. If the stock resumes from the base lower, you know something is wrong and its time to look for a better opportunity. But when it resolves to the upside, some of the best trades in the market are made.
Here are some recent examples of large base consolidations near highs:
All charts shown are Weekly Bars
HD
NKE
SBUX
BA
IP
New Base Opportunities:
TMO
Update: TMO +6.8%
UA
Update: UA +7.5%
ISBC
Update: ISBC +8.6%
FB
Update: FB +35%
*These charts were originally posted on 2/27/15 when the SP500 was trading at a weekly closing price of 2,105. I think its important to note that every single one closed the period higher from our original post date. The SP500 is currently trading at 2,056, a decline of -2.3% during that same timeframe. The takeaway isn't that we predicted which stocks would outperform the market or that the market would be poor in 2015. Rather it should be that stocks trading in a tight consolidation, especially near all-time highs tend to trade strongly when they move out of these bases to the upside. We don't have to predict the market to do well. We simply need to observe and react. A simple strategy of buying relatively strong stocks moving higher out of multi-month base formations can be an excellent way to identify great risk/reward opportunities.
Current Opportunities (12/28/15)
LOW (Long as of 11/20/15)
TSN (Long as of 10/9/15)
PANW
LOGM
PLKI
TSLA
With exception of LOW and TSN these other opportunities have not broken out of their current base formations. Until they do they should remain of watchlists for this particular strategy. But as we have seen before, stocks that consolidate sideways at new or multi-year highs tend to become market leaders when/if they do breakout to the upside.
They don't always work once they trigger, but you put the odds greatly in your favor with a setup like this. If they fail, your exit point is obvious and well defined. If they move in favor, one or two of these moves can make your year. Good luck out there in 2016!
For ongoing analysis and new base formations, please follow @ZenTrends on Stocktwits and Twitter.
Hi ZT.
ReplyDeleteThank you for share, I´ve learned a lot. I have 2 questions:
1. What is your guide to determine that the uptrend has finished and it is time to exit that position? using the 20w MA?
1. What is your recommendation for how many positions to have open at the same time?
Thank you!
TedGA
Hi Efrain, I determine a trend has ended once i see a combination of negative price action events. Typically I like to see (on the weekly chart for most positions) a new weekly closing low below the lowest close of the last 10 weeks (so new 50-day closing lows), a break and close below the 20w MA, And likely the prior swing low violation. That to me signals that the previous uptrend has begun to reverse course and I step aside. But keep in mind that is for my longer timeframe and others operate differently. It is important though to keep your stops far enough out of the way that they dont get taken out prematurely, but also close enough that you dont give back all your gains. This is the best Ive come up with at this point and it has worked well for me. usually I don't like a stop wider than 15% from the current price as a general rule.
DeleteAs for how many positions I like to hold is somewhere between 10-15 at the most. How I determine my position size is I will not want to buy more than 10% of my total account equity in a single position. But most importantly the size of my position will be based on a 1R maximum (or 1% of account size). So its either based on 1R risk or 10% of my account, whichever comes first.
But you should also figure out how much open risk you can handle within your own portfolio. If I hold 10 positions at 1R risk and they all turn against me and stop out, that will be a 10% loss. I usually dont like my portfolio heat to be more than 10%. Typically if I have 15 holdings, several of those will be less risk than a full 1R, either by trailing my stops or buying smaller amounts.
Also for total holdings, basically the market will determine when is the time to be more exposed or less. Sometimes I will only hold 1 or 2 names if conditions are unfavorable to my strategy. Fortunately we haven't seen an environment like that for some time. But we certainly will again, it always moves in cycles.
DeleteWith a trend following strategy the market will lead your portfolio to where it needs to be positioned. If the trends are strong we will hold many positions (currently right at our max), if the trend is indecisive or weak we will hold much less and wait in a cash heavy posture.
First of all, thank for your time to answer my questions, I really appreciate it!
ReplyDeleteYours is the first method that I see that uses a combination of events to exit a position, that is very interesting. What I understand from your answer is that it will be very difficult for you to get out of a position while the uptrend is there, and you will only exit after the stock has been sideways for a while or definitely has started a downtrend, am I correct?
I am new to the trend following strategy, I usually hold around 10 positions @ 0.5R (I usually buy 5% of my total capital in one position and add later another 5%), and also try to maintain my portfolio heat between 3% and 5%. In order to keep risk in that level I try to buy the position very close to the logical stop (normally the new highs breakout point or after it jumps off the 50 day MA). But sometimes after I add to a position the stock turns against me and suddenly my 0.5R is now 1R, and if I trail stops to maintain the 0.5R this new stop is very likely to be triggered, and is hard because I am sure the uptrend is still intact. So I liked your method that uses a combination of factors to determine that the uptrend has finished and also gives more room to a managed risk (1R vs 0.5R) that in my case can be applied to a position that turns against me after I just added to it, as the one I just described.
If you don’t mind, some other day I would like to ask you more questions about trend following to have a better understanding about how to apply it in the market. As you can see I am still learning.
Thank you!
You are welcome. I am happy to answer your questions. We are all always learning, others have helped me along the way and I am happy to help if I can.
ReplyDeleteIt sounds like you are focused on risk management as a top priority and that already puts you ahead of 95% of investors in the market.
When it comes to adding to positions, in my experience its better to wait to add to a new holding until you have already trailed your stop higher. There are some that have rules such that you only add to a position once it shows at least a 20% profit and/or held the position for more than 6 months. This assures that the initial entry has gone in your favor. Your risk is always highest at the beginning of a trade. To get overly aggressive early in a trade, it may not have proven that your initial entry thesis was correct.
I tend to avoid adding to positions in general, partially to cut down on costly (over time) commissions. But I would also only add if the trailing stop was less than a .5R open risk. If you look back at my last Lg Cap Portfolio review I explain this with my IP position. Where the trailing stop was moving to, my current R was only .3R and could then add an additional .2 R to bring my risk back to .5R.
Also, how are you determining your initial entry size. Are you locating the stop, calculating that distance from your entry and then dividing that difference by your .5R amount? or just buying 5% of your account and placing your stop at a certain loss level?
I have found it counter productive to just buy the same amount per trade regardless of where the reasonable support is. Always be sure to size your R risk by the distance from your predetermined stop and current entry price.
Well, you just give me several good advises that I am going to take into account for sure.
ReplyDeleteYes, you are right, after some painful losses I decide to give top priority to risk management, and started to investigate, read and learn about it. I am now deploying my first trades trying to assess and mitigate risk. But after your comment, is clear to me that I need to wait longer and give time to the trade to prove itself and I have already trailed my stop higher. I will use this advice for sure in the future.
I am going to take a look at your Lg Cap Portfolio review and I´ll be back with my comments/questions.
Excellent question, what I am doing is always buy 5% of my account IF when I locate the logical stop (previous BO, 50 day MA or some other strong support) that stop is at 0.5R or less of risk. If the risk is greater than 0.5R then I don´t buy it. That is why I try to buy as close as possible to the stop. I used to put it at a certain loss level, but after a while a realized that I was just giving away money because that stop didn´t have any meaning from a strong support point of view.
But yes, I think it could be more useful to size position calculating the distance from my entry and dividing the difference by my 0.5R amount.
I have found very valuable this conversation with you. Thank you and I´ll be back with more comments
Hi ZT.
ReplyDeleteI reviewed your IP example about when you add to one existing position. I see what you mean about waiting until the position gives you a new entry point and you can trail the stop. This brings me a new question: how you trail your stops? is the lowest swing low closest to the 20 week MA?
Thank you again.
By the way, may be these three topics can be subject of future publications: 1) how to exit from a position when the uptrend has finished. 2) How to manage risk based on 1R risk and 3) How to trail stops in trend following (at least in your timeframe). Just some ideas.
Yeah there is a lot of material that can be covered by those topics. I will consider it. I do always post all my Lg Cap Portfolio exits in the weekend updates. But I dont typically go into great detail.
ReplyDeleteTrailing stops is one of the most important aspects to successful investing, how you choose to place them can mean the difference of catching a great move or getting stopped out prematurely. Nothing is ever perfect but I tend to trail stops only when the basic "stop criteria" that I use for an initial stop location are in place. That would be a new 50-day closing low (lowest close of last 10 weekly bars), breakdown of the 20 WMA and usually a swing low violation. I like to focus my trailing stops on a confirmed support area (usually a prior high retest and then new resumption of trend after the retest. That low would need to be below the 20 WMA and confirm a new 50-day low. basically the stock would need to see a normal counter trend pullback AND THEN further weakness below a key support area. I consider 50-day lows and the 20 WMA as key support levels for a normal pullback . But the stop should be trailed to a location that you would not have much doubt that the trend is invalidated for your timeframe. If an uptrend is defined by higher lows and higher highs, once you see a lower low and/or lower high that should be plenty to convince you that something has changed.
Do know that its important to have established rules for your stops, but you also need to take into account the current volatility of the stock and how its behaving, sometimes a little tighter or looser stop is needed to get through a particularly difficult time. Ive mentioned a similar situation with CSCO and how it may require a looser stop as it tends to like to shake out my typical timeframe and stop method. Its always a good idea to review the stock you are considering to see how it trades according to your plan. If it continuously violates the 20 WMA while maintaining its uptrend, then you know that the 20 WMA isnt that important to this situation and would need to either pass on the stock or adjust slightly to compensate for that.
This stop method of mine mentioned here is also mainly for Lg Cap stocks. If you are looking at Small/Mid Caps, or Commodities, often you need to adjust the timeframe to account for the change in volatility. I trade both Lg Cap and Small/Mid Cap stocks in different accounts depending on the risk profile of the account. I use different stop methods for those. Both are trend following strategies but they are altered to fit the environment. I only share my Lg Cap portfolio because most casual traders can't handle the swings with the smaller stocks.
Hope that helps.
It definitely helps a lot. I think that your process for trailing stops is very interesting. I am going to study this method in my current positions to see how it looks.
ReplyDeleteThank you for all your help!