At the risk of stating the obvious, entering and exiting a position is the hardest part of trading. There is always a constant struggle between taking small losses, taking small profits, and letting your profits run in the hope of taking big profits. Ok, time to put the kids to bed, turn down the TV, kick back in the recliner, and fasten your seatbelt because this is going to change the way you trade.
By now you should have a good feel for what support and resistance is, how it is created and destroyed, and hopefully a fairly good understanding of how to spot it. If not, don’t worry, this will come with practice. First, I would like to go over some basic rules and then we’ll talk about the challenges of entering a position long and short, and finally we’ll talk about getting you out of a position at the right time, hopefully with a profit.
I’d like to discuss some simple rules for trading stocks and then we’ll look at a few charts. In the interest of time, and space the list is drafted assuming you are long. Just reverse the scenario if you are short.
1. Enter your long position when it breaks out above resistance and look for strong volume to confirm the move. Strong volume is not necessary for shorts, as we will see a little later.
2. Start with an arbitrary stop of -10%. I say this for two reasons. First, it is easy to calculate, and, second, I’m never willing to take a loss over 10%. You also need to be aware that a stock can easily drop 10% in one day so adjust your level of risk accordingly if you have a difficult time shrugging off 10%.
3. Now that you have your arbitrary stop, look at the chart. Do you see a recent bottom that is close to your 10% stop? Yes? Place it there. This is very important because it is very common for stocks to trade down in the A.M., following a nice move up on the previous day.
4. If the stock immediately moves in the direction you want, you need to begin tightening your stop but at a slower rate than the stock is moving – again, not exactly under todays bottom. If you do this you are risking getting stopped out at the open only to find your stock go higher later in the day. I’ve found that, in the early part of a trade and, as a general rule, you want to stay approximately 1 ½ days behind the most recent lows. For example, on a percent-wise basis, you buy a break out and find your stock has moved 6% higher than where you purchased it. You want to move your stop up about 3%.
5. You are sitting on a nice profit and your stock is approaching your target. What do you do? If the stock trades through your target on an intra-day basis ONLY, let it run. Don’t get in the way of more profits. Targets are just an aid. If there was ever a part of trading that is more art than science this is it, especially if your target doesn’t coincide with a recent high. For example, it’s Monday morning and your stock is just under your target of 20.00. A surge of buyers step in and push your stock to 21.00. Do you sell it at 20.00? No, let it keep going as far as it wants to. If it turns around and starts trading below 20.00 you simply sell. If it keeps going to 30.00 you just sit back and enjoy the ride – don’t get in the way of more profits.
6. You find yourself in a stock that is beyond its target. What do you do? Give it every opportunity to keep going, but don’t get greedy. Stocks rarely go past their targets without taking a break. Get ready to aggressively take profits.
7. You find yourself in a profitable stock that hasn’t hit its target and it starts to pull back. This is the toughest part. Do you take profits or let it retest the break out point? I can show many more charts that retest than I can that don’t. This is a very common occurrence. There is no simple answer to this but… if the markets are overbought you don’t want to let your stock move much against you. If the markets are oversold and beginning to turn up then you can let it pull back and give it a chance to resume its march higher toward the target. Again, this is the toughest part. Getting good at this comes mostly with experience.
8. You find yourself in a stock and it begins to move against you almost immediately. What do you do? This is the secret to successful trading. Strong stocks don’t break out and pull right back. You have to realize that it is normal for a stock to pull back after a nice move past the break out point, but it is not normal for a stock to break out and immediately fall. You want to be very careful here. Start moving your stops up at a faster rate than you would if you were in a profitable trade. Try to tolerate at least one day against you provided it doesn’t exceed your risk tolerance. If the stock goes green the next day then you are back to zero days against you. If you get two consecutive down days you should be taking your loss, depending on how much the stock dropped. If you’re down say, 6%, you’re out. If you’re down 2% you should still give it a chance.
9. You find that you have purchased a stock that has broken out on low volume. You don’t want to immediately sell it. Give it a chance, volume can show up. Be cautious, but give it a chance.
10. Rules are made to be broken. This list is just an aid and depends on where the major markets are. Overbought – be cautious with longs. Oversold – be cautious with shorts. Don’t expect to trade with 10 basic rules and expect to be an excellent trader. Just use these rules as an aid and learn from experience. Again, these rules don’t work all the time. Market conditions change constantly and you have to change with them.