Winning Stock Trading or How to Recognize When You’re Wrong

cash-burn volatility

Winning Stock Trading 

Winning stock trading is not easy. To make matters worse, new investors rarely ask the most important questions of all, when putting their savings to work. What am I willing to lose, and is this the right time to invest? A follow-up question needs to be pondered as well, how do I recognize when I am wrong? We highlight some examples in this short post, so keep reading.

If you’ve ever listened to Cramer, one of the most common themes goes like this. “My wife and I have $5000 dollars to invest, what should we do with the money?”

Cramer usually answers,

“with that amount you should invest in an index fund. Once your account reaches $10,000, only then should you start thinking of buying individual stocks in a diversified group of candidates.

That’s great advice, and I agree with most everything Jim Cramer has to say. However, and this is important, how does an investor know if this is the right time to buy? Additionally, how can we tell when we are wrong?

How to Recognize When You’re Wrong?

When writing my first book, “Think Like a Professional Trader” my mission was simple and straightforward. To be successful, you need to be aware. To be aware, you need to have reference points. Showing new traders what I’ve learned in my 30 years investing and trading helps readers avoid the obvious pitfalls. Hopefully, you learn what works, without suffering the consequences of your own mistakes.

Being conscious of cycles in the stock market and the stocks therein aides in navigating points of entry. One way of doing this is identifying phases and referencing where your stock is in this cycle.

Phases

Where are we?

Below is an excerpt from my first book, discussing the four phases in a stocks evolution or “cycle.” 

“Phase one is the accumulation phase, when institutions establish positions. This is followed by the markup period where traders and investors bid the stock price higher. The peak comes at some point as earnings may disappoint or the stock starts to see bad press, this is the distribution phase. Finally comes the markdown phase where prices can fall quickly. With most strong companies, the process starts all over again as institutions feel confident the stock or company has run its course. They start accumulating shares again.”

This works on any time frame, though phases are more emphatic on the daily and weekly.

Let’s look at some examples.

Apple (AAPL) appears to be experiencing some distribution after a lengthy Phase II – markup period. This weekly chart illustrates price action spending more time below the moving averages in the most recent time period. If the price action falls lower we can assume Phase IV is starting. Buying AAPL now is not a high probability trade.

AAPL Weekly Phases

NFLX illustrates distribution at the top left, followed by markdown or phase 4, as price spends more time below the moving averages. Since we are looking for a long entry, we look for Phase 1 accumulation, where we see price action move sideways. When contemplating a time to enter, we are looking for Phase 2 “markup” where price moves above the moving averages.

The trigger is price action moving through the green line. Buying NFLX as a short-term “day trade” is a high probability setup, as RSI moves through 50.

NFLX-02-02-2018

Renko and Long-Term Trends – Winning Stock Trading

We have all heard the phrase, “the trend is your friend.” Elaborating on this concept and pointing out where we are relative to this trend helps an investor establish a benchmark or reference point. Establishing a reference point assists in making educated decisions.

If we eliminate noise from our decision-making process or workflow, we can increase our probability of success.

Renko eliminates the “noise” by focusing on price. Time is irrelevant. A signal occurs only when a change in price meets set criteria. The criteria: A close (2.50 +/- points) higher or lower from the previous close. This point range was chosen since closing prices have been contained within a 2.50 point range, close to close since before November 2016. Intraday price action on the other hand often exceeds 2.50 points, so establishing a benchmark of 2.50 up or down from close to close creates a consistent data point where a close outside the extreme triggers a signal.

In the chart below a red brick printed on Tuesday after SPY closed -2.50 points lower than Monday’s closing price.

The referenced chart of SPY shows the trend very clearly. Red bricks tell a bullish trader to tighten stops, consider taking profits or going to cash. SPY has only recently printed red bricks, with all white bricks since March 2017. With the exception of the setback (red brick) in March, a trader would have safely traded the trend for roughly 14 months.

Renko

Caution: a change is underway.

Renko also tells an investor that a change in market character is underway and that she should take notice. Continuing to trade as usual after a red brick print can only lead to mistakes.

A red brick is important, as it signals “caution or change in trend”. Additionally, this change is telling the investor to reassess market conditions and at the very least stop trading until more information can be studied. To put it another way, trading as if we are still in an uptrend when the signals clearly point to a new downtrend will only lead to losses.

All is not lost though, as the sooner an investor acknowledges the change, the easier it is to make up for lost profits. A 5% loss is much easier to overcome compared a 10 to 15% loss. We like to say “let the math work for you.”

Stop Loss Back to Even

Current Thoughts 

SPY is currently 3.90% below recent highs. A possible downtrend is developing, so we need to pay attention. If we have open positions, we need to consider taking profits on any bounce. We need to reduce exposure and eliminate risk. We exit with profits where we can or take small losses. If the trend moves lower, we won’t incur more losses. It also gives us time to reassess the trend. If Renko prints a white brick soon, we will begin the process of looking for a resumption of the trend. Without a white brick, we will not add risk.

SPY Weekly 4 percent drawdown

By utilizing the ideas above, we can better understand if we are entering the markets at the right time. Now that we have a reference point, we can calculate the market’s probability of continuing with the trend or if the trend is starting to end.

Understanding where the markets are positioned, at any given moment, will lead to better decisions. Understanding these principles will help you avoid high-risk situations (more losing trades). Conversely, understanding these concepts will enable maximum potential profits as we trade with the trend

If you’d like to learn more about how we have managed to trade successfully for over 30 years, join us at the Closing Print. We trade and broadcast on LIVESTREAM during market hours.

Good luck and happy trading,

Vinny



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Disclaimer:  Do your Own Research

Our content is intended to be used and must be used for informational purposes only. It is very important to do your own analysis before making any investment based on your own personal circumstances. You should take independent financial advice from a professional in connection with, or independently research and verify, any information that you find on our Website and wish to rely upon, whether for the purpose of making an investment decision or otherwise.

Investment Warnings

We would like to draw your attention to the following important investment warnings. The value of shares and investments and the income derived from them can go down as well as up; Investors may not get back the amount they invested – losing one’s shirt is a real risk; past performance is not a guide to future performance.

Vinny Gambini

Trade Fundamentals w/ Technical Analysis - CANSLIM method using high probability setups and Ichimoku Trend Analysis. Architect, Family Man and Father of three.