Setting Your Own Objectives - Part 3:Trading Ideas

I'm still working my way through 'Trade Your Way to Financial Freedom,' fortunately I'm getting to a more interesting part that deals with trading and not as much with if I cry at weddings...

What kind of markets do you want to trade? Is it appropriate to specialize? Do you want to trade only liquid markets, or are there some illiquid markets you'd like to trade?

• I want to trade common stocks listed on the NASDAQ or NYSE with a price greater than $10 and average shares traded daily greater than 300,000. I'm not interested in anything else.
• It's appropriate for me to specialize in this area because of my limited experience, the availability of resources, and there is just no need for me to try to get 'fancy.' There is plenty of opportunity for me in common stocks.

Do you want any conditions to set up before you enter the market? If so, what are those conditions?

• I will only buy stocks when the market is in a confirmed rally by the CAN SLIM system definition.
• I will not ALWAYS buy stocks when this is the case, I also look for strong, clear market leadership to emerge. I identify this by watching the number and quality of leading stocks breaking out, which is necessarily subjective.

What beliefs do you have about entering the markets? How important do you believe entry to be?

• I believe I will only succeed when I invest with the current market trend.
• I believe entry is critical, particularly in respect to the health of the overall market at the time of entry, the purchase of a stock as close to the proper buy point as possible, and correct position sizing to maintain the proper risk exposure.

Given your goals in terms of returns and draw downs, what kind of initial risk stop do you want? If it's close, will you be able to get right back into the market so that you will not miss a move?

• I think the second question is flawed, and a bit strange. Fear of missing a move is not a strong quality for a trader to have, in my opinion. I fear loss of capital.
• My experience with stops is that when I allow myself a range (this percent to that percent is acceptable) I almost always harm myself moving the stop around from the initial point I choose. CAN SLIM dictates you never lose more than 8% on a trade, and I've never violated this rule. However, I'm leaning toward a set 5% stop on every trade. If a stock drops much more than 5% below the buy point, I'm not sure I'm interested.
• Stops get more complicated as I average up into a position. This raises my cost basis, and I have to then reconsider the stop loss. If I make my initial purchase at the pivot point and my next purchase 3% above, my cost basis is now above the pivot point. If I set my 5% stop loss off of my cost basis, then I'm not giving the stock as much room to work - I can get shaken out by a healthy pullback. On the other hand, I don't want to risk additional capital on a trade from averaging up, that is contrary to the purpose.
• Considering all these factors, my decision is that I will never let my stop loss order exceed 5% of my cost basis in a stock. 5% is a loss that I can live with. If I see a number of successful stocks shake me out and move on to big gains, I will reconsider this decision.

How do you plan to take profits? Reversal stops? Trailing stops? Technical stops? Price objectives? Contrary to popular opinion, much of your emphasis should be in the area of stops and exits.

• Answer - all of the above! My rules follow below.
• Stop Loss order 5% below purchase price
• If the market tallys five Distribution Days in four weeks, sell stocks up less than 20% immediately, order a 5% trailing stop on those up over 20%
• Trailing 5% stop if the stock is up 20% in more than three weeks from the breakout
• If the stock price rises 20% in less than three weeks move the stop-loss order to break-even and try to hold the stock at least eight weeks. This may be the most subjective sell rule I have, and what I will look for is does the stock find support at the 21 day moving average.
• Sell on Climax Top action as defined in 'The Successful Investor'
• Sell if the stock loses 21 dma and fails to recover it within a day or two
• Penalty Box - No trading allowed for three weeks after three consecutive failed trades

What do you do in terms of position sizing?

• My initial purchase is as close to the buy point as possible, for 33% of my total capital.
• My secondary purchase is 2.5-3% above the buy point, for 16% of my capital.
• With the current amount of capital I have, I will not own more than two stocks at one time.
• As my capital grows, I will adjust my position sizing plan accordingly.