Now that I closed out of my TRXC position after holding it for a year and a half, its time to get back to stock trading and doing it right. I’ll detail the first three trades that I made here, and the techniques I’m using to protect myself while looking for an opportunity. I can definitely say that having money in the game really does push you to spend time doing your homework and studying stocks. I’ve spent more hours in research this last week than I have in the last year and I’ve already discovered that my chart reading pattern and price bar skills are rusty. I need some practice before I’ll truly be able to follow what is happening in the market and whether trends will continue or reverse. *
Pilot Positions
One technique that I’m using for the first time is “pilot positions”. Rather than put all of your money down on a stock all at once, you buy a small number to see if your idea actually works. If the trade works in your favor, you can add money to your position (also known as “pyramiding”) with confidence that you are on the right side of the trend. If the trade turns against you, the pilot position is so small that the losses are minor and easily recoverable. This technique is often discussed by famous traders like Jesse Livermore and Nicolas Darvas, although G.M. Loeb recommends and even wider stop of 20% for small cap stocks given their volatility. I would only do that though with a much smaller position size.
To that end, I limited my trades this round to $5,000 per position. As I described previously with the 2/6/10 rule, I like to keep a wide 10% stop loss to avoid getting whipsawed out by the market; with a position this small my losses are kept to $500. This is easy to swallow in a $100,000 portfolio and after the 6% loss rule I would need to mess up 12 times in a row before I’d be forced to stop myself and reconsider my methods. With 3 years of experience under my belt I know how to correct myself well before that happens.
And to those who blanch at the thought of losing $500 so easily, and that I am ridiculously stupid doing this: (a) if you can’t risk losing money you should never be in stocks, period, and (b) a $500 loss on a trade would actually be a huuuuge improvement on my past gambling behavior where I could lose thousands in a day. Stock trading, like swinging a baseball bat at a fastball, is a game of odds. Even the best only have an 50%-60% average. By getting out quick when losing money and nailing down the correct direction of a trend, I can jump in when I am more certain of what’s going on and earn a killing as a result.
Time Limits
I am also implementing a time-bound rule as I mentioned in my other article on having a basic stock trading framework. Rather than wait weeks, months or years for a stock to prove itself, I am giving it 5-12 days to make money. According to research done by Pascal Willain in his book “Value in Time” the odds of a stock becoming profitable after this point drops considerably. If you’re right, you should be making money immediately. Anything other than that is wrong and you should act accordingly.
Seed Sowing
Lastly, I am taking a “seed sowing” approach. I will make a number of small bets on several stocks, deploying only a small part of my total capital, before pyramiding the majority of my money into those positions that prove profitable. This should also hopefully give me an idea of the general direction of the market and which way I should go to follow a trend. I am bearish by nature and love to short stocks and watch them crash, but what’s really important here is making money. If the picture is pointing to a bull market, then that is where I need to go.
The Trades & Outcomes
But on to the trades! I picked three stocks this time around that looked like they might make a decent profit. HMY is a gold mining company based in South Africa, VRX is pharmaceuticals, and HCA is in the healthcare sector. Other than some background research I did in HMY two years ago (where I missed a flipping 400% bull run!!) I know nothing about any of these companies. All I’m watching is price, volume and trends. In particular I am looking for counter-trend trades, i.e. that price will reverse. This actually is the opposite of what I’m trying to do – trend following – but these stocks just stood out to me and I decided to hop in and get my feet wet.
In the case of HMY, there was a strong positive divergence in the MACD indicator and the RSI indicator was oversold and the price was at the resistance level. The short term trend is down – which is bad – but the other signs indicated it could bounce up and net me a solid 10-30% gain. I made my $5,000 bet going long at $1.78 with a stop loss of $1.60…and the price promptly dropped and hovered at $1.70 for a few days before the bottom finally fell out of the barrel earlier today and the price hit my stop loss. This was a case where I should have followed my instincts however because I sensed that there was simply no buying occurring at $1.70. Price will not increase unless large amounts of people buy and this just was not happening. I should have increased the stop loss to $1.70 and forced the stock to prove itself right then, and saving myself a few hundred dollars.
As it stands, I may actually jump back into this stock on the short side and try to follow the trend downwards.
In the case of VRX, the price had stopped near the prior resistance level, volume was dropping over the last few months, the MACD was going down and RSI was overbought. It seemed like the advance would fail and fall back from $22 to $16, netting me a 28% profit if I shorted the stock. However, the selling volume did not grow as expected and price seemed to hang at $22 for some odd reason. It seems clear that some of big hands (insitutions) were moving in the background and I tightened my stop loss from $24.35 to $23. This proved to be a good idea as the stock jumped shortly afterwards and I got stopped out for a loss of $200 on my $5,000 position. As you can see, I’m already learning from my HMY trade 🙂 I’m now thinking of reversing my trade and following the trend upwards.
Much like with VRX, with HCA I was betting that the advancing price would fail and drop back down. The indicators were less promising than on the other two bets, but the selling volume actually seemed to increase over time, which gave me hope that it would tumble. Considering what happened with VRX though, I now plan on tightening my stop loss to $106 from $116 and force the stock to prove itself. This would limit my loses to ~$130. I don’t need to lose all $500 to know I’m wrong.
Lessons Learned
So what have been the lessons so far? First, my recent experience has shown that the pilot position concept is brilliant. I am way less stressed out with these smaller positions and can easily recover from any losses. I can also take wider stop losses and avoid getting whipsawed out if I simply get into a stock too early in the trend. If anything, I don’t think I took the concept far enough and plan to decrease my pilot position budget to $1,000 so that I can apply a 20% stop loss. Compared to some horrific numbers I’ve had in the past (like a $5,000 loss in a few days) a $200 loss is laughable. I can also take a few more positions this way and it will force me to do my research as a result. I will also see what I can do to apply the trend-following concept to my screens so that I can properly identify stocks that are ripe for speculation.
In any case, I’ve opened some other positions since these were made and I will describe them in my next posting.
* Speaking of which, I highly recommend “Investing with Volume Analysis” by Buff Pelz Dormeier and “Trades About to Happen” by David Weis. They aren’t enough to trade with on their own, but combined with other trading theories they are dynamite. They’re like an alternate lens on a telescope giving you a different magnification. If you are looking for planets orbiting stars, the telescope can point you in the general direction while the other lens helps you watch the stars wobble due to the planet’s gravity.
