The Trailing Stop

Angel Food Headed to Hell

If you are trading in your IRA, then you can skip this post, as it's a shortie.  There are an awful lot of them as of late.

Here's one I would classify as high-probability: It's Sara Lee, who had a nasty crater as of late. Typical of big craters like this, the bargain hunters and true believers are coming around to pick up a bit here and there, but not enough to make a difference (notice the declining volume on the subsequent rise).

Chart courtesy of StockCharts.com

I would look for SLE to come back up close to the 50 day MA before heading down to 22 or beyond. The volume should settle in the next day or so (Fed worries should help settle it quickly tomorrow), and then I would pounce with a 2 ATR stop, which should hold even if it decides to fill part of the gap.

Study Probability for Fun!

I forgot most of what I learned in college. After all, I studied Architecture and have never practiced a day.

For those of you looking to bone up on your probability, I have run across a free introductory text at Dartmouth. You can find it here. Did I mention that it's free?

The Basic Elements of a Good Trading System

Every trader has a system. Not every trader knows it.

To do well in the markets, you need to know your system. Knowing your system encompasses a number of elements. The first to note is the your part of the sentence. The system you use should be your system. That doesn't mean you have to come up with every idea and every element on your own - on the contrary, there are many smart folks out there that can give you some good ideas.

Making a system your own means that you have an answer for every element in the system, and you have tested the system to an extent that you have a reasonable understanding of it's performance in different markets.

The following elements are needed in order to have a complete system. Note that the more specific each of the criteria, the better your system. Specificity will be key in tuning your system over the long term.

Personality
To get started in creating your own system, I believe that a very important first step is to understand your own personality in a trading scenario. We'll touch on the subject of trading psychology more in future posts, but for today let's keep it simple by asking ourselves two simple questions: First, what time frame would I like to trade? Second, what is my appetite for volatility?  The answers to these two questions will help you to filter various systems down to those that you can trade.  The most perfect system in the world is no good if you can't stick to it!

Money Management
Some call this rick management or position sizing. All it really means is that you have a system in place to prevent losses and manage risk. One example would be that you never risk more than 2% of your current portfolio value on any one trade. 

Filters
Filters are used to narrow the trading universe down to a starting list to examine for setup conditions. For example, you may with to trade stocks between $10 and $50 only, thus reducing the universe of stocks from over 7000 down to around 3000. Other filters such as fundamental indicators, EPS, earnings growth, etc. should all be defined in  very specific conditional terms.

Setup
A setup is a condition that makes a stock say  "Hey! Look at me!".  The best setups can be programmed so that you can automate the scanning of the market for new issues that meet your setup conditions. Example: Today's high is the highest high of the last 80 days.

Entry
This element alone is often viewed as a system unto itself. Bill O'Neil of CANSLIM and Investors Business Daily fame has a number of excellent entry indicators in his popular book How to Make Money In Stocks. The entry condition will tell you when it is OK to go ahead and watch that stock you've had your eye on in the Setup list.

Exit
The single most important and the single most overlooked element of a system. If you don't have an exit component, then it's not a system! This will be one of the least discussed and hardest elements to design, but don't despair - many others have come before you and successfully designed their own systems. If worse comes to worse, just pick something simple such as "if the issue moves against me for three days in a row". As you begin testing your system you will refine your exits, so don't worry about getting it perfect.

Optional Elements
As you progress through testing your system, you may wish to add additional elements such as portfolio balancing, equity curve analysis, market exposure rules, etc. For now, focus on the basic system and understanding how it behaves in the markets.

In the next post we'll explore how to get to know your system's personality.

New Beginnings Should Come Often

When I peruse a blog for the first time, the question lurking beneath the  placid (or flaccid?) surface of my mind is "Is this blog for me?"

Since the Trailing Stop is a new blog, you can't examine my past posts to get a sense of what is to come, so I'll do a bit of crystal ball gazing for you.  The following is a list of things you are likely to see discussed in future posts on the Trailing Stop:

• Stock systems and stock system development
• Back testing
• Interesting stocks (and WHY they look interesting!)
• Trading psychology
• Trading for a living
• Books, Blogs, Sites, seminars, etc about any of the above

I have made some very large sums of money in the market, most of which I subsequently also lost in the market.  Over the last few years I have been working very hard to learn from my mistakes and begin to shape the beginnings of a next career trading my own account.  Most of this learning has been through a great deal of reading, research, and trial and error, and I'd like to share that learning with those of you that would care to come along.

My hope is that I will learn from teaching, and perhaps help someone else along the way. For those of you that have encouraged me to write a book, this will have to do for now. When I have a yacht to go along with all of the good advice, I'll contact  the nice folks at Addison-Wesley!

In the coming days, I'll discuss why systematic stock development is the right answer for many and how to determine whether it is right for you.

Does Winning Get Your Blood Flowing?

It's getting late, and you should have stopped when you were up by $500.  Or at least by the time you got back down to even.  Now you're $1500 down, and you know that you are getting too tired to play effectively, so you are going to call it a night. Any moment now.

To reduce the agony - and maybe to end up the night even - you slide out what would normally be an insane bet - $1500 - half the entire stake you brought to the table tonight. This goes against every rule that you tell yourself that you have - but sliding it all out there give you a huge rush, and your hear beats in your throat as the dealer makes his way around the table.

The first pass throws you a jack of diamonds. Could it be? Is there possibly an ace in there for me? You glance over at the show and try to remember what has been dealt. The shoe - a five deck shoe - holds no clue, and your fatigue prevents you from remembering. At this point you are depending on hope. The player to your left gets a string of low cards, finally sitting on a 17 and hoping against hope against the dealer's 10.

As the dealer's hand turns over your card - you imagine the slow-mo - you see the ace and the blood rushes throughout your body. Yes! You did it! Not only are you up for the night, you have an amazing, last ditch effort, I-had-the-guts-to-bet-it-all story to tell tomorrow.

Do you recognize this story, or any of the feelings mentioned in it? The thrill of the win is something that a professional trader doesn't feel - or feel is a muted sense. Can you keep from feeling elated when a big trade goes your way? Do you ever slide you chips out on to the table - maybe too many of them - looking for the big score?

I know that I did - and occasionally still do, but this is no longer my standard mode of operation.  This type of trading is very exciting to me - and therefore ruinous! Excitement has no place in day-to-day trading. Ed Seykota often says that we all get what  out of trading - and life.

If it's excitement you are looking for, you will usually get it!

All of this is a lengthy (sorry) prelude to the fact that the only way for most people to trade consistently and effectively is through the use of a well defined and executed system.

In the next post we will talk about the various components that make up a system.