Stan discloses his rules to sell stocks or even short stocks at the optimum moment.
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Earlier in the year we completed a review on Stan Weinstein book: Secrets for Profiting in Bull and Bear Markets. We covered some of the basic concepts but only briefly touched on the final third of the book; When to sell.
Let’s take a look at this highly important and often disregarded topic.
First, we remind ourselves of the core concept of Stan’s work, Stage Analysis, and the transition from stage 1 and 2, into stage 3 and 4.
Here we can see stage 1 the basing phase, stage 2 the advancing phase, stage 3 the topping phase and stage 4 the declining phase.
Stage 1 and 3 is an indication that an equilibrium has been achieved between buyers and sellers, and price will often consolidate in a sideways fashion, this is accompanied by the flattening of the 30-week moving average line.
The preferred time to buy a stock would generally be within this green shaded area, whilst the preferred time to sell a stock would be in this red shaded area, although further consideration should be made to find the optimum time within each area.
In many cases (which Stan refers to) the optimum time to buy is here on the exit of stage one, and perhaps a less preferable time to buy here.
Conversely, the best time to sell or short a stock would be here on the exit of stage 3 and the lesser preferred time to short a stock would be here.
Remember, Stan is all about playing the odds and by keeping within this framework you move the odds in your favour…
Today we focus on protecting our positions and selling stocks which often end up here..
Stan says:-
“The sell decision is crucial if you are going to really win big in the market. Unfortunately, few market players ever master this important step”.
Rule one.
Always have a predetermined stop order.
Advice suggesting a 5, 10 or 15% stop loss is meaningless on its own and can often move a winning strategy into a losing strategy. Such arbitrary levels have no logic, a true effective stop loss must have an objective reason, and this is rule number 2.
Let’s imagine we buy a stock which has broken out of a stage 1 consolidation, and price continues its trajectory over the following few weeks.
The initial ‘objective’ reason for a stop loss could be just below the break of resistance which now becomes a new support level.
As the price continues, we look for reason to raise the stop loss and protect profits. Advocates of a set percentage approach may suggest a 10% trailing stop loss which could perhaps see the stop moving to here, but without any objective reasoning or relationship to the structure of the chart.
The professional trader however would likely see further patterns appear within the chart, providing objective reasoning for a raised stop loss.
Have a predetermined, objective, initial stop loss and look for reason within the chart to raise the stop as price moves higher. Stay away from arbitrary percentages.
Stan talks us through an example template, stock XYZ, and shows us the theory of trailing stops with specific rules.
We identify the stages, stage 1, 2, 3 and 4.
We also establish the 30-week moving average line.
The price breaks out of consolidation at stage 1, above the 30-week moving average and we purchase the stock at just under $21.
The stop loss in this example is initially placed below the consolidation support line, at just under $18.
Probability would suggest that price will continue its trajectory into stage 2, which we see here.
Before we consider raising the stop loss from its original position, we need to see a form of correction. We see a correction here at point A, with price retracing to point B.
We wait for the price to revert to its recent high, at which point we can now raise the stop loss.
Stan suggests raising the stop loss to just below the 30-week moving average line, at point C and directly below the last retracement. We now have two layers of defence, the support line, created from the retracement bounce, and the 30-week moving average line.
We continue to raise the stop in a similar manner to points E, G and I.
The next observation we need to make is the flattening of the 30-week moving average line and the forming of stage 3, stage 3 is considered high risk and a tightening of risk management is needed.
At this stage, the tactic changes slightly, instead of moving the stop under the 30-week moving average, we move the stop under the 1st considerable price retracement, marked here as position K.
Eventually price loses its momentum and drops below the raised stop, before continuing its larger scale retracement into stage 4.
Stan says:-
“Move out of your position with surgical precision just as you entered it with your buy-stop, and since a stock usually drops very rapidly when it first moves into Stage 4, you'll get out before the pain begins”.
An old chart from the book is presented to further demonstrate the theory, using the stock Skyline Corp.
Although the quality of the chart is questionable, Stan suggests that an entry could have been seen here at point B, a break above the 30-week moving average, followed by an initial stop at point A.
We then look for temporary pullbacks to raise our stop loss position whilst the stock progresses through a stage 2 advance.
Along the way we see several significant pullbacks followed by reversals to new highs.
At each pullback, the stop is raised, directly under the price lows and underneath the 30-week moving average.
The stock eventually started to plateau into a stage 3 consolidation, close to the flattening 30-week moving average line, and soon dropping below. The stock was sold, and the price continued its descent into a stage 4 decline.
Ultimately, Stan captures the bulk of the move whilst protecting his profits along the way, recycling his funds from stocks sold, into other stocks breaking through
Stan emphasises the importance of selling stocks at the right time when he says:-
“Just as it takes more time and energy to push a boulder up a hill than for it to fall, so it is with stocks, both gravity and fear bring things down in a hurry”.
Using the same XYZ stock template as we did before, Stan demonstrates how using the same stage 2 technique in reverse we could take advantage of a stage 4 decline, by selling stocks short.
We know we would have exited our prior long position here at the break of the support line, whilst the 30-week moving average line began to plateau.
Stan suggests we could simultaneously sell the stock short at the same time, by entering a short sale at the break whilst looking for an objective reason to place a stop loss, which we see here at a retracement.
The first action we see is a drop, followed by a retracement and a further decline.
The stop is then moved in accordance with each retracement downwards, ensuring that its position is above the declining 30-week moving average line.
At some point we see the 30-week moving average line plateau with price often consolidating in a sideways action, whilst creating a resistance line.
If price breaks through resistance, we close our short position. If price also moves above the 30-week moving average line, we could consider this a new stage 1 breakout and perhaps switch to buying a position on the long side, anticipating a new stage 2 phase.
Another working example is offered through a chart from the stock Dow Chemical.
At this point we won’t need to go through each specific aspect, although the same principles apply from the short entry, to protecting profits at each retracement, all the way down to the exit and plateauing of the 30-week moving average.
I think Stan summarises his position management approach best when he says:-
“Even though the market will definitely throw some frustrating curves at you along the way, this is the disciplined, unemotional, and profitable way to go. Always protect all your positions, both shorts and longs, with stops. Remain entirely mechanical no matter what headlines or TV news flashes you see”.
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