The following information is provided to assist you in
understanding the basics of
Step #4 - Tighten-up the Stops
In these FAQs, we cover . . .
What is a Stop Trigger Point?
Why do Stop Trigger
Points need to be refreshed?
How are Stop Trigger
Points determined?
What is a Price Resistance
Point?
How are Price Resistance points used to determine Stop Trigger points?
How
do we know it is time to consider adjustment to a Stop Trigger Point?
Where can we learn more about
Refreshing Stop Trigger Points?
Onward and upward . . .
What is a Stop Trigger Point?
Answer: A stop trigger point is a stock price beyond which we are
uncomfortable in holding a position in a stock. Stop trigger points serve one of
two purposes - either to limit losses (this is their initial purpose for new
Positions), or to lock-in profits (this becomes their purpose as paper profit's
form and build). Thus, stop trigger points serve as an additional risk
management tool supplementing the protections provided by Sell and Cover Stock Configuration signals.
There are two types of stop trigger points:
- Sell-Stop trigger points: These serve to trigger a Sell point for a Long
position. If the price of a Long position falls below the Sell-Stop trigger
point for that stock as of the weekly close, it is time to Sell all or a portion
of that stock.
- Cover-Stop trigger points: These serve to trigger a Cover point for a
Short position. If the price of a Short position rises above the Cover-Stop
trigger point for that stock as of the weekly close, it is time to Cover all or
a portion of that stock.
Specifics about what to do when a Sell-Stop or Cover-Stop is triggered (or
violated) are
discussed in the FAQs About Exit Signals & Actions.
Why do Stop Trigger
Points need to be refreshed?
Answer: It is all about risk reduction - reducing the losses we could incur
on new Positions that take an adverse turn and reducing the risk of losing paper
profit's on mature favorable Positions. Periodically adjusting trigger points
recognizes that as the price of a stock changes over time, our comfort level
with where we should get out of the Position changes along with it.
How are Stop Trigger
Points determined?
Answer: Stop trigger points, whether Sell-Stops or Cover-Stops, are
determined by looking for recent points of resistance as a stock's price travels
upward or downward. When we initially establish our stop trigger points, we look for
the most recent areas of price
resistance in the stock's price. When adjusting Stop Trigger points, we likewise
look for price resistance points, until such time as we begin reliance on the 30
week Moving Average which serves as our Stop Trigger guide from that point
forward.
What is a Price Resistance
Point?
Answer: Stock prices when examined from week to week, rarely move in a
straight line - they move in more of a zig-zag fashion. It is this zig-zag in
prices which provides price resistance points.
For example, a rising stock (one in which we are perhaps holding a Long
Position) will rise in price for several weeks in a row. Then it will pause and
fall slightly for a couple of weeks. Then it will begin to rise again and under
desired circumstances, continue to rise above the point it rose to previously
before it takes pause again. When we graph these movements over time, the
zig-zag of the stock (as viewed in hindsight) becomes very visible as Hilltops
and Valley-bottoms. These points where the stock price stops to change direction
(i.e., the Hilltops and Valley-bottoms) are what we are referring
to as resistance points. This same phenomenon occurs with stocks that are
falling in price, but of course in the opposite direction. Our Action History
Graphs were developed specifically to view these price resistance points, in
relation to the 30 week Moving Average.
The more visually pronounced the Hilltop or Valley-bottom appears, the more
significant it is. For example, a Hilltop resistance point formed after an eight
week ascent is more significant than a Hilltop resistance point formed after
only a three week ascent. Also, the more repetitive a Hilltop or Valley-bottom is, the
more significant it is. For example, a stock rises to form a Hilltop resistance
point at the same price level two, three, or four consecutive times is more
significant than a single occurrence at that price level.
How are Price Resistance points used to determine Stop Trigger points?
Answer: We select recent Valley-bottoms to serve as Sell-Stops and recent
Hilltops
to serve as Cover-Stops.
When we are holding a Long position, it is almost as if to say, OK, we can
see that on X date, the price fell to Y. We recognize this and we are willing to
allow the price of the stock to fluctuate to as low as that level again. But we
will not tolerate it if the stock closes below that level.
Likewise, when we are holding a Short position, if we see that on X date, the
stock's price rose to Y, we recognize this and we are willing to allow the price
of the stock to fluctuate to as high as that level again. But we will not
tolerate it if the stock closes above that level.
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 our action histories, 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 a 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 a 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.
How
do we know it is time to adjust a Stop Trigger Point?
Answer: We have rules we like to adhere to.
Adjusting Sell-stops - Sell-Stops are initially
established off the stock's most recent Valley-bottom at the time of the Buy. When a new higher
Valley-bottom forms (after a confirmed subsequent Hilltop), and is confirmed
(after three subsequent weeks of
ascending closes), it is time to adjust the Sell-stop at the new
Valley-bottom, rounded down to the nearest dollar. However, if the new Valley-bottom forms above the stock's 30 week Moving Average, it is time to
begin using the 30 week Moving Average as the Sell-stop guide. To use the
30wk as a Sell-stop guide, we use the actual value of the 30wk Moving
Average rounded down to the nearest dollar. As the 30wk moves upward, we
move the Sell-stop in one dollar increments.
We never adjust Sell-Stops downward (except to correct a mistake -- yes,
we occasionally make mistakes and -- yes, we correct them, if it is not
too late).
Also, we never adjust a Sell-Stop to a level above the current week's closing price.
Adjusting Cover-stops - Cover-Stops are initially
established off the stock's most recent Hilltop at the time of the
Short-sell. When a new lower Hilltop
forms (after a confirmed subsequent Valley-bottom) and is confirmed (after three subsequent weeks of descending closes),
it is time to adjust the Cover-stop at the new Hilltop, rounded up to the
nearest dollar. However, if the new Hilltop forms below the stock's 30 week
Moving Average, it is time to begin using the 30 week Moving Average as the
Cover-stop guide. To use the 30wk as a Cover-stop guide, we use the actual
value of the 30wk Moving Average rounded up to the nearest dollar. As the
30wk moves downward, we move the Cover-stop in one dollar increments.
We never adjust Cover-Stops upward (except to correct a mistake). Also, we
never adjust a Cover-Stop to a level below the current week's closing price.
When you examine the individual stock's in Professor Profit's Portfolio (by
clicking the ticker symbol link in the Current Holdings or Closed Positions
tables), you can observe the above rules in action. Each stock's position page
includes explanations as to how the above rules applied. In addition, you may
find the accompanying Decision
Trees helpful
in determining when Stop Trigger points require adjustment and to what levels.
Where can we learn more about
Refreshing Stop Trigger Points?
Answer:
There is much to learn about Refreshing Stop Trigger Points at Learn
More.
That concludes the Step #4 FAQs
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