Trailing stops and taking profits (was: RE: [CANSLIM] AAII letter to the editor)

From: "Katherine Malm" <kmalm@earthlink.net>
Subject: Trailing stops and taking profits (was: RE: [CANSLIM] AAII letter to the editor)
Date: Tue, 15 Jul 2003 20:42:47 -0500
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Hi Hong,

I think you might be confusing the use of the 7-8% rule. You have to think
of a stock in several stages for this to make sense:

(1) The stock forms a valid intermediate term base (cup with handle, flat
base, double bottom, etc.). It sets up and breaks out above the pivot on
volume >=150% of average daily volume (ADV). Assume you enter at the optimal
buy point ($.10 above the pivot). Your purchase price is "just right" and
this is where the 7-8% rule applies.  That is, a stock which is still
healthy shortly after a breakout will tend not to fall more than 8% below
the pivot before it continues to rise. If you buy at the optimal buy point,
then you can then set an inital stop which is not only 7-8% below your
purchase price but also 7-8% below the pivot itself. That's the very reason
why you don't want to chase a breakout too far past its pivot. If you
purchased, say 10% above the pivot, the stock could fall to 8% *below* the
pivot and still be healthy. If you also set your stop at 8% loss from your
*purchase* cost, you will be shaken out for no practical or technical
reason.

(2) Once the stock starts moving up, then you need to decide where your stop
will be. There are many guidelines for this, but don't mistake a *price
drop* of 7-8% from one day or week to the next as a reason to get rid of the
stock. Instead, you want to look at the price/volume action of the stock and
determine if it remains *healthy.* For example, after a breakout, say the
stock rises very quickly to >=20% above the pivot. This is considered strong
follow-through and is often the sign of a stock that has real power.
However, it isn't uncommon for a stock which rises 20% or more very quickly
to fall back a bit on low or fairly low volume. Why? Because the short term
traders get in and quickly take their profits and ride into the sunset.
However, as a CANSLIM investor, you're looking for stocks that have the
wherewithal to withstand this sort of short term correction. What will most
often happen once the short termers influence the stock to slightly lower
prices will be the intermediate to longer term investors coming in a
scooping up more shares. That's why you want to stick with it....you're
riding the stock for bigger gains. As to your trailing stop, you may simply
raise your stop to breakeven at that point. In other words, you really don't
want to take any loss on a stock that has risen >=20%, but you also don't
want to be whipsawed out of a perfectly good intermediate term position
simply because of a temporary pullback. That's very often what sets the
stock up to launch further.

(3) As the stock rises, you want to look at the price/volume action itself
for any signs that the stock is in *big* trouble. These sell rules (see the
investors.com site) are much more subtle and take a lot of practice. You may
wish to move your stop up a bit as the stock works its way up, but be very
careful, once again, not to set it too tightly. A stock can and does remain
perfectly healthy, rising and falling, rising and falling, while the
underlying trend itself remains *up*. You want to stick with these winning
stocks as long as the price/volume action is healthy. Whatever you do, don't
set some arbitrary trailing stop at 7-8%, because it will have absolutely no
technical meaning to the behavior of the stock itself. Look for logical
support areas such as a trend line, a previous area of support, etc. (Again,
you can find a lot of info on this at the investors.com site.)

(4) At some point, the stock will stop its general upward trend and will put
in a fresh base. You have several options here. First, you can ride out the
consolidation and stay in the stock as it breaks out again. If it fails from
the area of consolidation, you can sell. You can add to the position as it
breaks out. You can sell as it starts the consolidation. Remember that an
intermediate term consolidation can be as little as 10-15% (flat base), to
20-60% for a cup with handle. Your decision to stay with the stock will be
determined primarily by the underlying health of the market itself, the
underlying health of the stock's industry, the underlying attractiveness of
the business itself, and you personal profit taking goals.

All in all, you can't make a general statement about what one *should* do
with a stock. You have to decide what you are *going* to do *before* you buy
the stock.

Katherine

- -----Original Message-----
From: owner-canslim@lists.xmission.com
[mailto:owner-canslim@lists.xmission.com]On Behalf Of Hong Hsu
Sent: Tuesday, July 15, 2003 7:01 PM
To: canslim@lists.xmission.com
Subject: Re: [CANSLIM] AAII letter to the editor


 >that stock will most probably not come back-even taking into account
that some stocks >do come back after losing more than 7-8%.

jans,

    I appreciate your response.   I am not sure I understand your
comments completely.  Take an example if I may ...

Let's assume a stock has solid fundies and it breakout with huge volume
from sound base.  One week after the BO, it gained 20%.   Next two day
or three, it gains another 5%.  At this point I am facing a decision:
 Take profit OR hold it to shoot 40% gain.   By holding it, the stock
may end up with 14% gain.  By same token, if the stock reached 40% gain,
then you have to decide either to take profit or shoot 60%.  Again by
shooting 60% gain, you have possibility to end up with 30% gain because
of volatile.

Do you think once a stock lost 7-8%, it will not able to reach new
higher?    Usually how long you are willing to hold a stock which made
30% gain within 4 weeks from BO?

- -Hong



Spencer48@aol.com wrote:

>Hong:
>
>     You didn't ask me, but...
>
>     The 7-8% loss rule is based on WON's experiences in the Mkt:  Many
times
>he has written that stocks that lose 7-8% (assuming that they are bought on
>the BO), do not BO again.  In other words, not selling at this time could
be
>dangerous to your capital.
>     Moreover, while you are correct that a stock can come back after a
7-8%
>loss, according to WON if the stock had been bought at the correct time (ie
on
>the BO), then that stock will most probably not come back-even taking into
>account that some stocks do come back after losing more than 7-8%.  This is
>because the stock has run up above the BO point more than the 7-8% stop
loss point.
>     Additionally, even though the stock does not continual to lose, I
don't
>believe you are taking into account the opportunity cost of holding a stock
>which is not moving, but you hope will eventually rise.  Holding a stagnant
>stock means, while you may not be losing nominal dollars, you are losing
the
>opportunity to invest in  a stock that is moving up.
>
>jans
>
>
>In a message dated 7/13/2003 11:14:20 PM Eastern Daylight Time,
>honghsu@bellatlantic.net writes:
>
><< I am thinking to use price progress and time to determine stop,
> something like Parabolic System from  http://www.tradertalk.com/,   OR
> simply use %, but instead measure from entry point, you measure it from
> first pivot OR Fibonacci retreat line.
>
> Your comments will be appreciated,
> -Hong >>
>
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