The Basic Philosophy

First let me say I am a trader, not an investor. I have no idea if the companies I buy today will grow and their share price will increase greatly over time.  A successful stock trade for me usually lasts 1-6 weeks, although I have held stocks longer. I am NOT a day trader. I do not buy options or other leveraged vehicles. I am a momentum trader with a twist. The system I developed is a breakout/momentum system that is tuned to get in a stock before it starts running.

Momentum trading got a very bad rap in the late 1990’s as people would buy a hot stock, which is not a bad idea. However, after the run up in price, they would also ride them all the way down, which was stupid. The secret of momentum trading is limiting risk – getting out for a small loss when you are not right, and knowing when to take profits. After a stock has spiked up in a short period of time, volume is very high at the top usually. Who these people are that are buying when a stock spikes, and what they are thinking, is a mystery to me. But I am happy they are there to buy when I take profits.

To take a position in a stock, I look for what I perceive to be a low risk entry point, i.e., low risk in terms of dollar loss if I am wrong. I have to believe a stock trade offers at least a 3/1 profit to loss ratio and that the stock can advance at least 25-50% in 6 weeks time. (This ideal pattern may actually never develop for many stocks I watch.) I trade a mix of stocks from it the $2 to $100 price range. Lower priced stocks tend to move in greater percentage advances but carry more risk.

My system involves various proprietary screening techniques that produces a large list of stocks that make my “watch list.” What I primarily look for is a stock that has had a strong run, then settles back and consolidates. This process can take weeks to months. I review this list of stocks weekly and after various screens are applied, a much smaller list is then generated which I believe has the potential to generate a buy (or sell) signal that week, based on price and volume action. All buy/sell signals that are generated from that list are posted here for regular paid subscribers. To give you a visual example, click on the following charts and you will see the set-up, the buy and the subsequent breakout and sale. I actually purchased LU at $2.94 on 1/2/04 and sold it at $4.75 on 1/16/04 and XING at $9.01 on 1/2/04 and sold it at $14.80 on 1/21/04.

I look to trade stocks that I perceive to be breaking out from either of one or two types of consolidations. A Type 1 stock has made a big move to new highs, then goes into a consolidation phase. A Type 2 stock has made a long quiet base/bottom, or if it has had a good run up, the consolidation, unlike in the Type 1 stock, is quite a ways from the top. At first blush, you might think trading Type 1 stocks would be more profitable, as there is no overhead resistance as the stock makes new highs. However, these stocks may initially surge faster, but they are often more inclined to run into major reversals. Type 2 stocks often take longer for their true potential to evolve, but if the basing process has been long enough and quiet enough (no big blocks of stock yet to be dumped), then the advance can be quite powerful and easier to read as it proceeds. Why is that so important? Read on.

Exiting a Trade

A successful trade has an entry point but the exit point is not predetermined when the trade is made (like a stop loss is). There is no specific "target price."  There is a lot more “art” and “feel” to reading the market action to know when to exit a trade. I often like to scale out, selling half my position first. This has been particularly effective, especially on stocks that spike dramatically higher (see my best trade for 2003, XYBR).

You will hear high paid analysts say, for example, their target on IBM is $95 this year. The fact is when you trade there is no target. I try to read the chart, analyzing wave patterns and measuring the momentum of the stock, and when I perceive it has peaked, I get out. Perhaps that works out to be near the top. Perhaps not, and after a correction it goes onto the next leg up. Sometimes I get back on, if it lets me, sometimes not. What do I mean if it lets me? I need to see a quiet consolidation and then a break out. Why quiet? Simply, because a quiet, tight consolidation reduces the perceived risk, and I like low risk trades. I buy a new high breaking out of certain chart patterns and my stop is below the consolidation pattern from which it broke out. If there is no consolidation, or equilibrium, over a number of days, the risk is usually too high for me to consider trading the stock. There has to be some rationale for a stop loss price and determining it by some percentage, while perhaps good in defining your dollar risk, is pointless in terms of measuring meaningful price action, as opposed to fluctuating noise.

For example, I want to buy XYZ as it clears its recent consolidation high of 6.58 and the low of the consolidation is 6.34, a tick below which is our stop loss point. If the stock goes through my buy stop, then I know my risk in the trade is approximately $0.25. I say approximately because I may not get those exact prices.

When you become a paid subscriber you will get a link describing stops, as well as other order types, and how to implement them in entering and existing markets as well as other more sophisticated order strategies. You will also have access to that day’s actual trading signals (entry and exit points).

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It is important to realize that the system I use generates many trading signals, from just as few stocks to as many as 40+, depending on market conditions. All signals that get filled will comprise the System Composite Portfolio. Many buy signals cannot be taken in my real time accounts, because often I am fully invested, and therefore there is not enough money in my accounts to buy all the stocks from the system. If you choose to use the system’s buy signals, you also will find yourself in the same position. Thus your account will not necessarily exactly mirror my performance, or the total performance of the System Composite Portfolio. This will, at times, will be to your advantage or disadvantage, depending on what stocks you decide to buy and how many shares. I too out perform or under perform the System Composite Portfolio.