Developing an Investment Strategy:
Relying on your own judgment rather than using an adviser can be wise, it depends on whether you have the time. You’ll find that the more you use others for advice the more you are dependent upon them. When you accept someone else’s opinion, they may change their opinion and brokers are reluctant to put out sell orders especially when they just made a buy recommendation. You need to be the person who sets the criteria as to when you should sell an investment.
It is also wise to do practice trading, you never want to just jump into something. I use a site called Worden TC2000. You can perform market scans to find investment ideas and you can also track and protect your investments with trend lines and alarms. The cost is about $30 a month and they will give you a couple of weeks for free.
What do I mean by scanning for investment opportunities?
I try to deep it simple. I’m looking for a stocks that are breaking to new highs, and that are just entering the markup phase. I am buying a stock that is just coming out of a base formation and therefore my risk is somewhat reduced.
Step One, The Scanning Process:
I choose to use a scan that looks for stocks that have hit 120 day new highs, this can be done from “easy scans” on TC2000. Once the scan is completed you’ll have a list of companies. I look for companies that have been in an accumulation phase as shown in the chart above. I’m not looking for stocks that have already seen large appreciation.
(An area of accumulation forms where informed sources buy a stock with the intention of marking up the price. At the same time less informed sources tend to sell in that same area of accumulation. It is usually identified by an increase in volume on upward advances and a contraction of volume in downside moves).
In this case I have identified J C Penney as a stock worthy of consideration. Please recognize that I feel strongly that the stock market is in the final stages of the bull market advance. However, if I was looking to invest on the long side of the market this is the way it would be done. In a bear market decline most all stocks retreat.
Step Two, Reward to Risk Ratios:
Anytime you buy a stock you are assuming risk. If the stock price goes against you, unless you decide to sell, you could see your investment go to zero.
I use point and figure charts from StockCharts.com as a way of assessing reward to risk ratios, as well as, determining price objectives. You can learn more about point and figure charts by clicking here. I will assume that you have read and understand point and figure charts as I proceed with this dialogue.
Let’s take a look at the point and figure chart for JC Penney:
The price count from the $9 level on JC Penney is 9 points (6 X 3 X .5= 9). I would put a sell stop (An order to exit a trade if the market proves your initial decision to enter the trade as wrong) at $7.75 (which is a very tight stop loss) to protect my investment since the short term trend line would have been violated (see blue chart above). The resulting reward to risk ratio would be 9/1.2 or just above 7.5, that is a good ratio.
Let’s assume that J C Penney has reached its price objective of $18. What now? You need to determine if the stock is going to move higher, there may be a period of re-accumulation. If the stock is going through distribution it is time to exit. You can protect your investment with the use of trend lines and stop loss alarms.
Let’s take a look at Apple Computer in the later part of 2012. It appears on closer look that Apple is actually going through distribution (volume increases on declines and volume decreases on advances, plus there is a head and shoulders formation that can be ominous).
So, what happened to Apple’s stock at a time when the stock market was booming?
It took a dive of over 300 points from the top to the bottom. What were the point and figure charts telling us?
A count from the 625 level shows a count 225 or an objective of 400, a level that was reached. Just because the markets are red hot doesn’t mean that every stock will perform well. You surely don’t want to see your profits evaporate.
It is wise to remember this chart:
It is so important to have a method, a way of approaching the markets and making good investment decisions. Hopefully, you can learn these methods with me over time. It is important that you test drive your approach to using these techniques before you actually invest your hard earned money.