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Thanks to everyone who attended the MTA webcast “Technical Analysis for Establishing Proper Market Entry and Exit Points.” As usual, I received more great questions during the presentation than I had time to answer. So I am continuing the discussion here:
Q: How would you characterize the strength of the current market uptrend relative to other notable bull markets?
A: This market uptrend has been very strong. The last time I had this much confidence in an uptrend was the fall of 2010. That uptrend started in September and lasted into the end of the year. The good thing about the current rally is that it’s nice and broad with many groups participating. Even value investors like this rally because valuations are attractive. The leading stocks are doing exactly what we want them to: after breaking out of recognizable bases many are moving up 20-25% and beginning to consolidate again. Even the stocks that I was shaken out of earlier in the move are still making progress. That’s always a good sign.
Q: Do you compare volume to the previous day or to the Moving Average? What period of Moving Average are you using on volume?
A: To validate a breakout on an individual stock, I compare volume to the 50-day moving average volume. I like volume that is at least 50% above that average. To validate Follow-Through Days and Distribution Days, I compare volume to the previous day. In either case, volume just needs to be higher than the previous day.
Q: If you are just entering the market now, up to what percentage of your portfolio will you expose before getting any profits? How many positions?
A: It depends on the size of the portfolio. Let’s take a $100,000 portfolio as an example. I would buy one or two positions and expose 20% of the portfolio. Once you have a profit cushion on these positions you can wade a little deeper, and add to those positions. Then, after you’ve taken more profits and have a cushion in the portfolio, you can get a little more aggressive and increase your exposure by adding additional positions.
Q: If you keep shifting money from losers to winners, and you start with a portfolio of 8 to 12 positions, how many positions would you have towards the end of a market run?
A: The ultimate goal would be to have the heaviest concentration in the 2 or 3 best-performing stocks. That’s the best way to put up big numbers in the portfolio. This allocation is very difficult to achieve, however, unless you entered those positions properly, early in the move, and then added to those positions at low-risk entry points. It’s easy to screw this up, if you lose track of your average cost. The goal is to make big money when your stock selection id finally right.
Q: When you talk about wading into positions, are you talking about Pyramiding?
A: I do pyramid into individual stock positions (50% on the first buy, 30% for the second and 20% for the third) up to 5% of the pivot point. But wading in refers to the portfolio, not just individual positions. By “wading in” I mean beginning a new market uptrend with a small amount of the portfolio invested. As I begin to get traction, and my initial positions show me a profit, I “wade in” deeper and incrementally increase my exposure.
Q: Can you expand upon followup buys once you’re fully invested in a position? Say your full position is $20K. What is the most you would add to that position with followup buys?
A: It depends on the type of stock, your current average cost and how much risk you are willing to add to the position. I use the line pen in MarketSmith to draw a line on the stock chart to represent my current average cost and another line representing what my average cost would be if I made a followup buy. I decrease the amount of shares in the followup buy until I am comfortable with the new average cost. That exercise typically results in a new purchase of no more than 20% of the original position. The key is to not over buy and then get scared out later in the move.
Q: What type of Fibonacci studies do you use if any? Do you look at other technical indicators as well, e.g., Stochastics, MACD, DMI, etc.?
A: I am a purist when it comes to technical analysis. I rely on price and volume as my primary indicators, and I look for price patterns that expose support and resistance. I prefer to keep my signals simple to avoid the risk of signals contradicting one another.
Q: Is there a minimum percentage increase in price action for a Follow-Through Day? What indices are you watching?
A: Yes, I look for a Follow-Through Day to be up at least 1.7% on the one of the major market indices (NASDAQ, S&P500 or the DJIA). For a complete definition of a Follow-Through Day, click here: http://education.investors.com/financialdictionary.aspx?termID=5963&term=Follow-Through+Day+Concept&mode=searchResults
Q: How far do you let a profitable position fall before taking profits? Do you use stop loss orders?
A: I would much rather sell a position on the way up (when I reach 20% in profits) than sell on the way down. Decisions get more difficult to make if the stock begins displaying defensive sell signals, and you begin eating away your paper profits. I don’t use trailing stops, but if a stock begins to display some technical sell signals, I would start to begin taking profits (if I haven’t already). You can brush up on your technical sell signals by reading chapters 10 and 11 of How to Make Money in Stocks. Rounding tripping a profitable stock is a cardinal sin.
Q: Once you are in a position, how do you know when to exit?
A: This is where experience helps, but here are a few guidelines we use. We always want to try to maintain a 3:1 Reward-to-Risk Ratio. In a good market, when we buy, we will take profits at 20-25%. The one exception is that if the stock runs up 20% in less than 3 weeks, we will hold the stock for the full 8 weeks, because the stock is displaying a lot of power and has the potential to be a big winner. If the stock drops 7-8% from our purchase price, we cut our losses.
Q: Where do we sit today on the market, considering topping and distribution days? Are we near a slide?
A: As of 2/29, the distribution day count is only at 3 on the NASDAQ but the market has been up 8 of the last 9 weeks. So while a short-term pullback is in the cards, a full blown market correction is unlikely this early in the trend. For that to occur, the distribution day count would have to increase to 5 or 6 within a period of 25 trading days. For more details on this, check out the last webinar I did on “Staying In-Step with the Stock Market”: https://www1.gotomeeting.com/register/320616673
Thanks again for all of your great questions. If you missed the presentation, you can watch the recorded version here: http://media.mta.org/videos/2012/educational-web-series/scott-oneil/scott-oneil.html
Follow Scott O'Neil at Twitter.com/WScottOneil
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