I believe the most important part of my system is the identification of great companies. If your bank account was sufficiently large, you could simply buy stock in these great companies and sit on it. This may not maximize your investment but it would be the least amount of work. All you would have to do is monitor the continued success of the individual companies and re-balance occasionally.
The reality is that few of us are so wealthy that we can buy a sufficient quantity of 20-30 stocks to just sit on. This is why so many people invest in mutual funds that eventually under-perform the market. To offset this lack of funds, my system allows you to move your money between companies on your watch list and hold only those companies that are currently experiencing a bull market and avoid those that are moving sideways or downward. I call this system, GOPM (Growing on Other People’s Money). It works quite well at growing your stock portfolio in those companies that are on your watch list.
The heart of GOPM trading management is technical analysis or at least chart analysis. While I do not suggest that you are a pure technical trader, I think there are extremely good signals that you can follow that help you avoid the downturn in the market. I am not going to get into specifics on my favorite indicators, but here are some common sense nuggets that should be used with my favorite indicators as well as all others.
- After a long positive run, don’t jump back in 3-5 days later. If the stock is bouncing back and forth between sell and buy signals then you should interpret that as being a hold or wait.
- Avoid buying or selling when much of the finance industry is taking a long vacation. The most obvious periods where you should be hesitant to believe the charts and the technical signals are July 4, Christmas, and Thanksgiving. Just assume that the most senior traders are spending time with their families and the folks running the office are young enough that they can remember their first legal beer purchase.
- Don’t sell the day after you bought unless the stock just took a hit and there was a news event. This is a corrollary to number 1 above. Just because a technical indicator reversed on you doesn’t mean you should do a knee jerk reaction.
- Weird stuff happens during earnings announcements. Sometimes it works for you and sometimes it is against you. I know traders that purposefully sell their shares a week before earnings announcements just to avoid the crowd mentality of everyone going over the cliff like a lemming. I don’t necessarily subscribe to this waiting period but if I have had a good run with a stock, I may sit out for a week or two around earnings time.
- Be wary of false buy signals that appear in a sideways channel. It is important to learn how to recognize a sideways channel. Many technical indicators can give bad signals in a sideways channel so be suspicious of any buy or sell signal.
- If a company has been trending up or down for a while, don’t panic buy or sell when they have a momentary blip and the trend seems to be reversing. Wait a few days to see what is really happening. Companies usually continue to trend until they find a ceiling or floor. That limit is usually tested a few times before it is firm. The first apparent reversal of a trend is typically not a reversal and, at best, the first testing of a limit. Trading while the limit is being established only ties up your cash at best and possibly is money losing if the limit doesn’t hold.
Some thoughts for readers of my book, The Confident Investor.
For many of you reading this, this article will end here. However, if you are a registered owner of my book, The Confident Investor, I am sharing some further guidance that is uniquely beneficial to those readers. You can purchase my book wherever books are sold such as Amazon, Barnes and Noble, and Books A Million. It is available in ebook formats for Nook, Kindle, and iPad. It is free to register for any owner of my book. [s2If current_user_can(s2member_level1)]
- RSI is a soft indicator and not a must sell or don’t buy indicator. In my book I tell you to watch 70 on the RSI scale and not buy a stock if it has gone above 70. In reality, 70 is not a hard number and you dont want to overreact to cycling above and below 70 on RSI. There are times when a stock will go up to 71, drop to 69, then back up to 70.5 and then back down again. This is not the situation that you are trying to avoid. You simply want to avoid a stock going well above 70 (perhaps 72 and higher) and then staying there for a a couple days.
- MACD tends to be cyclical. It is often possible for you to assume that the MACD will go positive or negative soon. It is perfectly fine to get a jump on the market and buy or sell as the MACD starts to approach zero. This may slightly increase your profitability.
- One of the easiest ways to see a channel situation is by looking at the 5, 10, and 20-day EMA. If the gap between 5 and 10 is about the same as the gap between 10 and 20 then you need to be concerned that it is a sidways channel. This is even more true if the gaps have been roughly the same for a couple days or so. As I mention above, you need to be cautious about trading in a sideways channel.
- Be wary of down markets. Before you check to see your individual stocks, run the 3 main indicators of my book on the S&P 500 and the Dow Jones Industrial Average. These indicators (5,10,20 EMA, MACD, and RSI) will tell you if the market as a whole is dropping or growing. You may want to take this into account when you look at your individual stocks. There are times when the entire market is down that you may want to hold on for another day or two before selling your individual stock even though it’s indicators showed sell. Sometimes, when the market rebounds, your stock will rebound as well and you can stay in the stock for a longer period and make more money.[/s2If]