Getting Organized

In my last post I recognized that I've become a bit lazy in my approach to trading during the extended bear market. While I think my discipline has improved, my attention to detail has waned. The first action I took to address the issue was the documenting of my buy rules and position sizing plan. Today I'll take the next step and develop a plan for watchlist tracking.

I'll bet this is one of the most commonly ignored tasks by traders, and one that can materially improve results if it's done seriously. My coworker is a successful CAN SLIM investor and the first person to suggest to me some key items worth tracking on a watchlist.

What I think makes the watchlist so crucial is the insight it can offer in post trade analysis. Certainly I can always go back and look at a chart from the time I made a purchase, but with my watchlist I can track the some details like which screen identified the stock, what price I first noticed it, what the group relative strength was, etc. This allows me to later filter down the results of the stocks that make my watchlist and refine my process.

I'll learn if I'm more successful with stocks from a particular screen, or chart pattern, or industry group. I'll see if I avoided buying winning stocks and bought losers - and my notes (if kept properly) will tell me why I made these decisions. I also incorporated a link to the charts.

For anyone who loves free Internet resources like I do, google spreadsheets are great for this purpose. You can access them anywhere, share them with friends, and they have nifty functions built in which allow me to embed a live stock price and a link to the charts which I upload to my picasa account (picasa is a tool from google to manage images).

A quick note on the market - I'm starting to see more weakness than strength in the leading stocks. I don't know if the rally is over, but I'm in a bit of a wait and see mode now. (ARST) is holding up alright, and I see no need to pursue another purchase until a powerful looking stock comes along.

Buy Rules and Position Sizing

I think the extended bear market had some negative effects on my trading in addition to some of the positive effects. I was realizing today that I've gotten a bit sloppy, maybe even lazy, in the way I've been trading. I decided on the way home from work that in addition to the Sell Rules I have posted here I need to post my Buy Rules as a constant reminder the proper way to do things.

One mistake I made recently was the purchase of (TNDM) about ten days before the company is set to release earnings news. There is no 'official' CAN SLIM rule against this, but I've read about it and believe it's good practice to leave a three week buffer between the purchase of any stock and their earnings release. Would this mean I'll miss some winners? Certainly so. The buy stop I cancelled Sunday night was for a stock that went up over 10% today. Rules are not about individual situations - they are made to put the odds in my favor. If, over time I see this rule doing more harm than good I will adjust it or discard it, but for now I'm adding it to my system.

I guess I should mention the theory behind the rule. Buying a stock within three weeks of earnings news doesn't leave much time for the stock price to advance and provide some kind of cushion. Therefore, if the earning news is disliked and the stock tanks, I would be left vulnerable to a huge, even catastrophic loss. Better off to wait and if the stock is a real winner, another buying opportunity will present itself.

Another rule that I followed recently and want to document is 'buy strength, not weakness.' I'm proud that I did this on Monday when (TNDM) stopped out for a loss. Instead of getting attached to it and buying it back (trying to prove I was right about it), I channeled my capital into the stock that was working for me, (ARST). Buying strength doesn't just mean adding to stocks that are working, but also never adding onto a stock that is going against me. I must never make an addon buy at a lower price than my initial purchase - this will almost always end badly.

Next, on to position sizing. This was another lazy mistake I made recently, and a fine example how easily emotions can creep into trading without me even recognizing it. When I came off my three weeks in the penalty box, I purchase (ARST) and then a couple of days later (TNDM). I 'liked' (ARST) and I 'loved' (TNDM), so without giving it any thought, I had purchased a smaller initial position of (ARST) and a larger initial position of (TNDM). This is flawed for several reasons.

For one thing, if I'm not confident in the purchase of a stock, I shouldn't buy it in the first place. I don't think that I should have varying expectations for different purchases. I should either like the stock enough to buy it, or not. It can look like it has the right stuff, or not. There is no in between. Market conditions may dictate smaller pilot buys, but these should be equal for any stock purchased within a range of time.

Given that I believe a stock is worth buying, it makes absolutely no sense why I would purchase more of one than another. That would only be the right course if I knew which stock was going to succeed, which of course I don't and if I didn't, wouldn't buy the other at all! The math only works on a trading system if I treat all positions equally, and that requires a plan for position sizing. I'm going to add that to my blog tonight as well, and I'll detail it here.

Due to the small size of my portfolio, I will own a maximum of two stocks. As it grows (thinking optimistically) I will adjust this as necessary.

The first purchase in a stock will be with 33% of my capital as close to the pivot point as possible. I use buy stop orders with contingent stop loss orders at 5% below the purchase price. If the position is working, I can add on to it from 3-5% above the pivot point with 16% of my capital. Same numbers hold if I add a second stock to my portfolio.

If a stock and the market are working very well, I can consider purchasing at a secondary buy point (pullback to the 50 day moving average) on margin - but this would be evaluated very carefully and with a tight stop.

Sell Stop:(TNDM), Addon Buy:(ARST)

Well, I said yesterday that the market was due for a pullback, and we certainly got that today. As ugly as it was, I'm not ready to say the sky is falling. The market's had an amazing run off an ugly bottom and really needed to correct. Of course I'd prefer a gentler correction on lower volume (the Nasdaq volume was considerably higher than Friday), but with violent up moves come violent down moves.

The combination of the overall market and a downgrade shook me out of my (TNDM) position for a 5% loss. This stock still could do very well, but I'm through second-guessing my sell stop orders, I put them in and leave them alone now. I'm not going to be right on every trade, though I have to admit I'm anxious to log a winning trade - it feels like a very, very long time since I've done so.

Whenever I stop out I try to reflect on the general market and my plan going forward. I gave it quite a bit of thought today. The market has behaved very well, but the ride could end any time if folks remember that the economy sucks (sorry to use such a technical term). I don't know what it will do in the future, so all I can go on is the current state, which is a confirmed rally with two distribution days. Nothing to panic over at this point.

Next I looked at the two stocks high on my wish list, (TNDM) and the other that I had a buy stop order in on. There would be nothing wrong with entering another buy stop order for (TNDM) if it crosses the pivot again - some winning stocks do stop out before going on to big gains. However, I've decided not to put another buy stop in on (TNDM), and to remove the other buy stop order I had open, for a couple of reasons.

For one thing, both stocks release earnings a week from Tuesday. Best practice is to avoid buying a stock within three weeks of an earnings announcement. The reason for this rule is to ensure that you have a suitable cushion in case the stock takes a dive on the earnings release. I was willing to give (TNDM) a shot one time this close to earnings, but I won't do it again.

Secondly, when I consider my early trading history, one of the biggest problems I had was over-trading. Instead of being content with a winner when I found one, I continuously looked to add more stocks to my portfolio. The profits I made were overwhelmed by the losses.

Since (ARST) held up well today, I decided to add on to that position, which was working, rather than open a new position with some unproven stock. I added to (ARST) at $14.30 and $14.64 for an average cost of $14.42. We'll see how this approach works, and what the market has to say tomorrow.

Setting Your Own Objectives - Part 2:Defining Your Objectives

Continuation of the 'Setting Your Objectives' work from 'Trade Your Way to Financial Freedom.'

What is your advantage or edge in trading? What is the particular concept that you are trading that gives you an advantage?

• My advantage is that I trade a proven methodology - the CAN SLIM method. This system has worked for countless investors, so I know that if I'm willing to put in the effort it can and will work for me. I've studied many of the traders whose ideas and methods built the foundation for the CAN SLIM system. I'm willing and able to adjust the system to mitigate my shortcomings and take advantage of my strengths. I will not blindly follow the method, but instead will practice it earnestly and adapt it to fit me where it's appropriate to do so.
• CAN SLIM could be generalized as trend following, as much as the author of the system would rather it's not. My adaption of the system is particularly so. I've seen poor fundamental stocks rise in price and solid fundamental stocks fall, so although I target 'high quality' stocks, I'm willing to forgive some 'CAN SLIM criteria' when I see a great chart on a stock. I don't mind an ROE of 10%, for example (CAN SLIM specifies 17% as the minimum), if most other fundamentals are solid and there is evidence in a stock chart that the company is under heavy accumulation. I believe the laws of supply and demand govern the direction of a stock price, nothing else.

How much money do you have personally? How much of that money could you afford to lose? How much risk can you afford to take on a given trade?

• I won't disclose publicly my personal financial matters, but my trading account is small enough to be considered insignificant. Of course, I hope to change that by trading successfully.
• I could lose my entire trading capital and it would not affect our day to day finances.
• On any given trade I attempt to limit my exposure to 2% or less of my total capital. As small as my account is now, sometimes my risk on a given trade is slightly greater. If my capital grows to a substantial sum, I would try to reduce my risk to 1% of total capital on any single trade. It should be noted that I limit risk not by the size of my purchase but with predefined sell stop orders.

How much money do you need to make each year? Do you need to live off that money?

• I'm years away from living off the proceeds of my trading, but that is my ultimate goal. If and when I near that point, I will need to revisit this question and my overall trading plan.

What if you don't make enough to live off it? Can you make more than you need to live off of so that your trading capital can grow? Can you stand regular withdrawals from your trading capital to pay your monthly bills?

• Recent market history should make anyone planning to live off the proceeds of investments seriously consider these questions. My plan is the same now as it was two years ago, but was reinforced by the recent stock market crash. I would need to follow one of two paths in order to live off of trading. I would either set aside enough cash to live off of for three years without making a penny and trade the remainder, or I would invest enough in some fixed income product that delivered enough income to live on and trade the remainder. Both are very conservative approaches, will take longer as they require a great deal of capital, but will afford me peace of mind.

Are you being realistic, or are you expecting to trade like the best trader in the world? For example, suppose you have a very good system that is right half the time and gives you profits that are twice as large as your losses. In that system, just by chance, you could still easily have ten losses in a row. Your system is still working as expected, but you could easily have ten losses in a row. Could you tolerate that?

• When I first began trading I had visions that I would be a prodigy. I was certain that it wouldn't take me nearly the time to become a success that it had take other great traders. As with many before me, the market has humbled me and I believe my aspirations are now indeed realistic. My current objective is to beat the market and finish with a profit each year, after fees and commissions.
• Because my system is not fully mechanical, and at it's very nature follows the trend, I would not tolerate ten losses in a row. After three losses in a row, I put myself in the 'penalty box' where I cannot trade for three weeks. If I came from that and had another three losing trades in a row, I would have to take a very serious look at what the problem was - myself, the market, or more likely both. I probably logged ten losses in a row early in my career, and that's the motivation for me to develop a formal system - to avoid future failures like that.

Do you have the time to trade short term?

• No, and I don't have the interest either.

How much social contact do you need?

• I enjoy spending time with friends in my free time, but I don't need to be around people during working hours. I'm a bit of a lone wolf, and appreciate time I have alone at home.

Can you work by yourself day after day? Do you need one or two other people around, or do you need a lot of other people around? How much do those other people influence you?

• As stated above, I can take or leave social contact during business hours. I'd prefer not to have anyone around when I'm trading so that I'm sure the decisions I make are not influenced by them.

In summary, what do you expect to make each year as a percentage of your trading capital?

• I expect my expectations to grow with my experience. At this point, I'd like to make a 50% gain the first year that we get a new bull market (I don't know when this will come).

What risk level are you willing to tolerate in order to achieve that?

• I've covered this above, I try to risk no more than two percent of my capital on any given trade. If the market is going well, I would not be opposed to trading on margin. Therefore just using rough numbers, I think if I ever went 'all in' and the market took a fantastic dive I could potentially lose 10% of my capital at one time - this is the worst case scenario as I see it.

What is the largest peak-to-trough drawdown you are willing to tolerate?

• I'm not sure I fully understand this question. On an individual stock basis, I will not lose more than 7% on any one stock purchase.

How will you know your plan is working, and how will you know when it's not working? What do you expect from your system in various kinds of markets? Trending? Consolidating? Highly volatile?

• When the plan is working I will be right (profitable) on 40-50% of my purchases with an average profit around 20%, and an average loss of about 5% on the incorrect trades. I'll know it's not working if I have three losses in a row, at which time I will take a three week break from trading.
• The system works in an uptrending market, and other market requires me to go to cash.

New Buy:(TNDM)

The chart for (TNDM) looks even better now than it did the first time I bought it about a month ago. Of course I wish I hadn't sold it then at $22.90, but I had a good reason and was playing the odds so I really shouldn't regret the decision.

Instead, I've watched the stock and the overall market, and given the positive action of both I looked for another opportunity to purchase (TNDM). I got my chance when the stock pulled back to the 50 day moving average on April 8th, rebounding to close in the upper 60% of the day's trading range. This was a positive test of support, so from that point I looked for the stock to trade higher on volume 50% above average levels.

It did so on Friday, and at the same time passed a conservative buy point of $26.46 - ten cents above the recent high set prior to the 50 dma bounce. My order went through for $26.50, and the stock finished the day above the buy point on big volume, almost twice average.

I have one more buy stop order in for another stock that I like, and after that I will sit tight. My only concern now is that the market is certainly due for a pullback, and with my purchases being so recent I run the risk of getting stopped out. Nonetheless, I can't see the future so when I see a breakout on a strong stock in a market that is acting well, I buy it.

Setting Your Own Objectives - Part 1:Self-Assessment

I've promised myself for awhile that I was going to make the time to go through the process of creating a trading plan outlined in 'Trade Your Way to Financial Freedom,' and tonight I'm going to follow through. I'll admit that I can't see the value in all steps of the process at this time, but I'm certainly willing to give it a try and see what I come away with. I don't expect to agree with everything I read, but I will learn from it regardless.

How much time during the day do you have to devote to trading?

• One to two hours, mostly after the market is closed. I can sometimes look at the market during the day, but not on a reliable basis.

When you are trading, how many distractions can you expect to have?

• Quite a few while the market is open, my primary focus is my full time job. At home in the evenings I am usually able to work with minimal interuption.

How much time do you expect to devote to developing your trading system, to doing your personal psychological work, and to working on your business plan for trading?

• As much time as it takes. With a wife and a young child I have to balance my time, but this only means it will take me longer to spend, say, 100 hours of study - that might take me ten weeks where someone else could cover it in half that time. I will still get there, just more slowly

What are your computer skills? What skills do you need before you begin this trading venture?

• My computer skills are above average. Potentially I could write my own database and/or programs if this would be beneficial. I'm not sure what skills I need until I learn more about formulating a trading plan.

What do you know about statistics?

• I took some courses in college for my finance degree, but that was over ten years ago. I have no practical experience, and would need to brush up in this area

How would you rate your market knowledge?

• One step above novice. I know more than those who know nothing. I've done extensive reading on successful traders, particularly those who 'inspired' Bill O'Neil's CAN SLIM method. Most of my attention is paid to price and volume action, particularly weekly charts. I also watch the 10, 20, 50, and 200 day moving averages and the Relative Strength line, along with other signs of accumulation and distribution. I do not make use of other technical indicators at this time.

What are your psychological strengths and weaknesses, especially in terms of trading system development?

• I have a great desire for a 'mechanical' system - I would be much more comfortable if choice was replaced by a set of rules. I think this is a strength.
• I am a good starter but a poor finisher. I tend to be distracted by each new potential method or improvement, and this could prevent or delay me from finalizing a system. It could alternatively be a positive because I will be looking for constant improvement.
• I believe I will succeed - I think this is the more important ingredient.

How about your strengths and weaknesses in terms of personal discipline?

• I lack patience and discipline, both of these will be needed for long term success.
• I am humble and self-aware - I am able to identify my faults and therefore improve upon them.

Do you tend to get compulsive, do you have a personal conflicts, or do you have any emotional issues that constantly crop up, such as fear or anger?

• Yes to all of these. I sincerly hope that I can improve my entire life experience as well as my trading by getting a handle on my emotions. I am apt to get 'excited' by trading when it's going well, and depressed when it's going poorly. That's why I started the blog, why I do all the reading I can, and why I'm working on this trading plan now. I want to mitigate (if not eliminate) these weaknesses and accentuate my strengths.
• Fear and anger have definately driven far to many of my actions in my life, and I don't think things have ever gone well when I've acted on one of these emotions. Certainly not in trading.

Based on your personal inventory, what do you need to learn, accomplish, or solve prior to beginning trading? How will you do that?

• Well, it's a little late now, as I've been trading for nearly two years now. It's very clear what I need to learn - to take the emotion out of my decisions and run my investing like a business.
• I've already taken some steps toward this end, like this blog and reading this book and creating a trading plan. I'm not sure what will come next, but I'm open and looking for ways to improve always.

New Buy:(ARST)

Just off my time in the penalty box I made a small purchase today of ARST at a cost of $14.00 per share. This is just over the $13.95 buy point, and I waited throughout the day until about 3:30pm to get that price - I really didn't want to chase the stock up much past the pivot.


I read the chart pattern as a large, deep cup with a handle that formed with a buy point of $10.10 from the week of January 16th. The volume dried up very nice in the handle looking at the weekly chart, and then exploded on the breakout the week of March 6th. This was the week this new rally began, and it's a positive sign that ARST was one of the first stocks to breakout.

The stock easily advanced 50% from this breakout in just six weeks. Last week it tested support at the 50 dma and came directly off of it, setting the new buy point as the recent high of $13.95.

What I don't like about (ARST) is the relative strength line lagging a bit. What I do like is the massive volume surge as the stock has made this move. It looks to me very reminiscent of (TNDM), (SNDA), (NTES), the other notable winners in this rally.

I would say more than any other factor I now look for that trademark surge in volume with a ratio of something like five weeks of accumulation to one week of distribution as a stocks works on the right side of a base. If the stock breaks out to make an all time high like (TNDM) and (ARST), that's even better. If it's a recent IPO like (TNDM) and (ARST), again - even better.

I've set a 5% stop on my purchase. I still feel the need to build myself a strict set of documented rules for stops and other aspects of my trading. I think without a strict set of rules I will spend too much time (and money) second guessing my decisions. I'll tighten up the stops when I should let a stock run, and vice versa. I think I'm better off picking a fixed percentage and using it on all my purchases. It's something I'll have to spend more time working on.