The following information is provided to assist you in
understanding the basics of
Step #3 - Establish New Positions
In these FAQs, we cover . . .
Why is Step #3 – Establish New Positions important?
What is a New Position?
What is a Buy Signal?
What is a Short Signal?
What is a Stock Configuration?
What
are the Components of a Stock Configuration?
How
are Moving Averages calculated?
How
are Stock Configurations used to determine Buy and Short Signals?
What
are the Stock Configurations that serve as Buy Signals?
What
are the Stock Configurations that serve as Short Signals?
What do we do if we receive a Buy Signal or a Short
Signal?
What
is a Stop
Trigger
Point?
How
are
Initial Sell-stops and Cover-stops determined?
Where
can we learn more about New Positions?
Have at it . . .
Why is Step #3 – Establish New Positions important?
Answer: This is
the only step in the process where we
add New Positions to our portfolio. Selecting the right stocks is crucial. It is all about risk reduction. Two very important things happen
in considering New Positions:
-
We determine whether there are any new worthy candidates for our
portfolio. In this determination, we match-up Market Direction with
each stock’s recent price movements. This reduces risk by identifying only
those candidates that are directionally viable (i.e., consistent with the
Market). Once appropriate candidates are identified, we make judgments about whether we actually want to
create a New Position.
-
For each stock we have chosen as
portfolio-worthy, we establish an
initial Stop Trigger Point BEFORE WE CREATE A POSITION in the stock. This reduces risk by limiting
our losses in the event the position takes a turn for the worse. It is
inevitable that some of our positions will be losers. We always determine where
to get out before we get in.
What is a New Position?
Answer: For our purposes,
a New
Position is a new stock added to one's portfolio.
If we Buy a stock this week, we can say we entered into a
New Long Position. As a
Long Position, we expect the stock price to increase in value in order to
produce a profit (i.e., Buy low – Sell high). As long as we hold the stock it
is referred to as a Current or Open Position. Once we Sell the stock, we are no longer holding it
and it becomes a Former or Closed Position.
If we Short (or Short-sell) a stock this week, we can say
we entered into a New Short Position. As a Short Position, we expect the stock price to decrease in
value in order to produce a profit (i.e., Short high – Cover low). As long as
we hold the stock it is referred to as a Current or Open Position. Once we Cover the stock, we are no
longer holding it becomes a Former or Closed Position.
What is a Buy Signal?
Answer: A Buy
Signal is an indication that Market Direction and the recent price movements of
a stock are such that it appears conditions are favorable that the price of the
stock will continue to rise in the near-term. Buy Signals are determined by
Stock Configurations.
What is a Short Signal?
Answer: A Short
Signal is an indication that Market Direction and the recent price movements of
a Stock are such that it appears conditions are favorable that the price of the
Stock will continue to fall in the near-term. Short Signals are determined by
Stock Configurations.
What is a Stock Configuration?
Answer: A
Stock Configuration is a combination of several Moving Averages of a stock's
weekly closing price.
What
are the Components of a Stock Configuration?
Answer:
A Stock Configuration consists of four Components, as follows:
-
Price of
the Stock - as of the most recent Friday's close;
-
5
week Moving Average of the subject Stock’s weekly closing price
– utilized to monitor short-term movement of the Stock;
-
15 week Moving Average of the subject
Stock’s weekly closing price –
utilized to monitor intermediate-term movement of the Stock;
-
40
week Moving Average of the subject Stock’s weekly closing price
– utilized to monitor long-term movement of the Stock.
The most important things to know about the four Components are:
-
rank
- the value of each Component in
relation to the value of the other three Components (i.e., which
Component's value is Highest,
Center, or Lowest, etc...),
and
-
direction
- whether each Component moved UP or DOWN (increased or decreased in
value) in relation to where it was the previous week.
So, as an example looking at
the hypothetical “ABC Stock”, if the . . .
-
ABC
Close was at $24.00 the previous week and is at
$27.00 for this week (i.e., it is the HIGHEST of the stock’s Components and it moved UP), and the
-
ABC
5wk was at $21.80
the previous week and is at $23.30 for this week (i.e., it is the LOW-CENTER
of the stock’s Components and it moved UP), and the
-
ABC
15wk was at
$24.60 the previous week and is at $23.10 for this week (i.e., it is the
LOWEST of the stock’s Components and it moved DOWN), and the
-
ABC
40wk was at
$26.20 the previous week and is at $25.00 for this week (i.e., it is the
HIGH-CENTER of the stock’s Components and it moved DOWN),
. . . then the ABC Stock
Configuration for this week would look like this:
|
Current ABC Stock Configuration |
ABC Close - UP
ABC 40wk - DOWN
ABC 5wk - UP
ABC 15wk - DOWN |
How
are Moving Averages calculated?
Answer: Think
of Moving Averages in the convention sense. Moving Averages have a tendency of
smoothing-out the ups and downs in fluctuating data. Let’s look at an
example for the “ABC Stock”:
| Friday's Date |
Weekly Closing Price
of ABC Stock |
5 week Moving
Average |
| Jan 7 |
$20.00 |
- |
| Jan 14 |
$22.00 |
- |
| Jan 21 |
$22.00 |
- |
| Jan 28 |
$21.00 |
- |
| Feb 4 |
$24.00 |
$21.80 |
| Feb 11 |
$27.00 |
$23.20 |
In the
table above, the average for the 5 week period ending February 4, is $21.80
(that is, the average of $20, $22, $22, $21 and $24 = $21.80). The average for
the 5 week period ending February 11, is $23.20 (that is, the average of $22,
$22, $21, $24 and $27 = $23.20). It can be said that the 5 week average for ABC
“moved” from $21.80 to $23.20 from February 4 to February 11. Thus the term,
Moving Averages.
How
are Stock Configurations used to determine Buy and Short Signals?
Answer: Thanks
to Zahorchak, Stock Configurations have been rather neatly
classified into groupings to correspond with their appropriate Market Direction.
We have taken Zahorchak’s work a bit further by labeling the Stock Configuration groupings in such a way
as to correspond with what we have identified as the 5 major “Stages” of Market
Direction. In
addition, thanks to Weinstein, we know we can participate in stock trading
during both Bullish and Bearish Market conditions. We have applied some of
Weinstein’s wisdom about our ability to Short and Cover, to Zahorchak’s
Moving Averages methodology, thus making Stock Configurations bi-directional.
Bottom-line,
by knowing the Stage of the Market (i.e., Market Direction) and by knowing a
Stock's Configuration, we can determine whether a stock is a candidate for
one's portfolio via a Buy of Short transaction.
What
are the Stock Configurations that serve as Buy Signals?
Answer:
The Stock Configurations that serve as Buy
Signals are shown in tables at the following link:
Stock
Configurations – Buy Signals
What
are the Stock Configurations that serve as Short Signals?
Answer:
The Stock Configurations that serve as
Short Signals are shown in tables at the following link:
Stock Configurations – Short Signals
What do we do if we receive a Buy Signal or a Short
Signal?
Answer:
When we receive a Buy or Short Signal, we
do the following:
-
We take a look at the 5/15/40wk Moving Averages
(as shown in a Stock Configuration Graph for the stock in question). If we do not like what we see,
we discard the issue as
a candidate without wasting anymore time. However, if we find the graph
intriguing, we continue . . .
-
We remind
ourselves that holding a share of stock represents theoretical ownership in
the company that issued the stock. We ask ourselves, is there anything about this company
that we don’t like? Example: A reformed smoker may prefer to not trade tobacco
stocks. If not, we continue . . .
-
We take a
look at the closing price patterns in relation to the 30week Moving
Average (as shown in an Action History Graph for the stock in question).
If we like what we see, we establish a Sell-stop (for the Buy Signal) or a Cover-stop (for the
Short Signal) as an initial stop trigger point, and we continue . . .
-
We enter the New Position in our portfolio (if
we were actually investing in the stock, we would contact our broker and place
the order).
What
is a Stop
Trigger
Point?
Answer:
A stop trigger point (i.e., a Sell-Stop or
a Cover-Stop) is a pre-established point at which we are going to feel uncomfortable
about continuing to hold a position if the stock’s price crosses it. For
example, in the case of a Long Position, this discomfort would occur because the
weekly closing price has gone lower than we really want it to. In the case of a
Short Position, this discomfort would occur because the weekly closing price has
gone higher than we really want it to.
Look upon Stop
Trigger Points as if they were safety-nets. Stop Trigger
Points reduce risk -- initially by limiting losses -- ultimately by locking-in
profits.
How
are Initial Sell-stops and Cover-stops determined?
Answer:
At Professor Profit's Paradigm, when we establish a
Sell-Stop or Cover-Stop, we are looking for the most recent price resistance areas which
become evident by viewing a stock's Action History Graph. These price
resistance points appear graphically as independent Hilltops (which can
serve as Cover-Stops for Short positions) or Valley-bottoms (which can serve
as Sell-Stops for Long positions). We illustrate these methods in the Action History
Graphs of Professor Profit's Portfolio, as we apply
them.
In order to identify the
true Hilltops and Valley-bottoms, we use the following rules of thumb. These are not
cast in stone, but as you study the action histories in our Portfolio, you will find we follow them pretty closely:
Rule #1 - Every real Hilltop is
preceded by a Valley-bottom. One can only determine a Hilltop
in hindsight. One needs to be able to visibly identify an ascent and descent.
To aid in this identification, we typically require a minimum of three
ascending closes after a Valley-bottom (to confirm it), then we watch for the
peak of the Hilltop. After the peak, we require a minimum of three descending closes from
the peak as confirmation of the Hilltop.
Rule #2 - Every real Valley-bottom is
preceded by a Hilltop. Just like Rule #1 but upside down. One
must be able to visibly identify a descent and then an ascent. We require a
minimum of three descending closes after a Hilltop peak ( to confirm it), then
we watch for the Valley-bottom to form. After the bottom, we require a minimum of three
ascending closes as confirmation of a Valley-bottom.
Rule #3 - If the most recent confirmed Hilltop has
formed below the 30 week Moving Average for a Short Position, use the 30 week
Moving Average as the Cover-Stop guide. When using the 30 week Moving
Average as a Cover-Stop guide, we always round up to the nearest whole dollar.
Rule #4 - If the most recent confirmed Valley-bottom
has formed above the 30 week Moving Average for a Long Position, use the 30
week Moving Average as the Sell-Stop guide. When using the 30 week Moving
Average as a Sell-Stop guide, we always round down to the nearest whole
dollar.
Rule #5 - Use "Risk
Corridor" to control potential losses. We don't enter into positions
with an undesirable Risk Corridor. For a potential Long position, the Risk Corridor is the percentage
difference between the initial Sell-Stop and the Buy Price (calculation: (1
minus (Sell-Stop divided by Buy Price))). Likewise, the Risk Corridor for a
potential Short position is the percentage difference between the initial
Cover-Stop and the Short-sell Price (calculation: ((Cover-Stop divided by
Short-sell Price) minus 1)). Under 5% is probably too small (the stock has no
wiggle-room). Over 30% is probably too high (a +30% hit to the ROI is very
painful). We prefer candidates in the 10% to 20% range.
Observation will help you learn these.
Every stock in Professor Profit's Portfolio has a Position page with an Action
History Graph and explanations as to how and why we selected our Stop Trigger
Points.
Another way to learn this art is to
study the methods of the masters of this craft. Some reading references are
provided below.
Where
can we learn more about New Positions?
Answer:
There is much to learn about New Positions. Explore Learn
More.
That concludes the Step #3 FAQs
Next:
Back to Tutorial Step
#3 Continue to
Tutorial Step #4 Continue
to Step #4 FAQs Learn
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