My trading strategy

This is in response to a query posed on stop losses by aljendan. I have however decided to start a new thread which would lead to valuable feedback and opinions from the experienced traders here.

You will undoubtedly find a lot of articles on the internet and books covering stop losses. Infact, I looked into so many articles and books that I got totally confused So, I decided to type in a short write-up regarding this topic. This serves two objectives - One, any student of the market (we all are, by the way) who finds this new may benefit from it. Two, more importantly, there may be a healthy discussion regarding various techniques that people use. I invite everyone, novices and veterans alike to comment on this method, which will serve to improve me as a trader.

Instead of classifying stop losses in a traditional way, I thought it would be better if I could take you through one trade, which used stop losses. Again, this is not one of those trades that made a spectacular profit - Just a normal 10-15% real world profit

So we start off with this stock INDIACEM,(Please refer the attached annotated file). I have it on my watch list because it has had a decent run in the last few days (prior to Jan 20, 2006). I usually look out for stocks which have had a good run and try to enter them on their first pullback to the 9,20 or 50 day EMA. Also, I like my moving averages arranged in such a way (20>50>200) that we don’t see a death cross or a golden cross.

Today is Jan 23, the stock prints a "hammer" like candle. This can be taken as a high probability reversal pattern according to Candlestick theory. I quickly do a check and check my support level which is given by the simple slanting trend line - around 110. given the fact that I would enter the stock only if it exceeds today's high (around 118), leads me to believe that I risk a max of Rs. 8 / stock. Assuming that my account size is 1 Lac, and the fact that I don't risk more than 0.75% of my equity on one stock, gets me to a position size of (0.75% * 1,00,000) / 8 ~ 90 shares. I round this off to the nearest 25 and decide on a position size of 100 shares.

Also, as a supplementary, exercise, I project the target based on Andrew's theory which states that prices tend to return to the central line drawn off the last pivot. This gives me a rough target of Rs. 140 for the stock.

Next day, I watch the stock and wait for it consistently stay above the 118 (yesterday's high) and enter it if I like the price action on that day. Entry made on that day! Stop loss remains my trend line which also doubles up as a trailing stop loss.

The day after I enter the day, there is an ominous black candle which is a bearish reversal pattern. This makes me a little nervous and I decide to bail out if price on the next day after the black candle is lesser than the lowest low of the black candle. This however does not happen and there is a series of strong white candles which take me to about 140 levels. There are four days of sideways small candles after the big white candle. The fourth day however, prints a "bearish engulfing" pattern on the charts. This leads me to book partial profits on the next day. I sell 50@140 and decide to hold the rest until the trend line is broken. This happens after a few days and I get out of the remaining half at about 136. The price moves sideways after breaking the trend line for sometime before resuming on a new uptrend.

The essential thing to note here would be the fact that the trend line has acted as my stop loss throughout the trade. As a personal preference, I prefer to watch my price rather than place a physical stop loss order as it is also important to note the circumstances under which your stop loss is triggered to avoid whipsaws.

I include a few other indicators and volume into account when I make trading decisions but firmly believe that indicators that you use should support price action instead of the other way round.

One more thing to note here is to not get perturbed if the stock resumes the uptrend after you bailed out. You had your rules and reasons to bail out and it is more important to stick to the system. Take care of your discipline and the profits take care of themselves

I understand that this post covers more than just stop losses, but then stop losses have to be an integral part of your trading strategy and not a stand alone thing that you would use. The treatment also has to be similar.

This is just one person's system and philosophy of entering, position sizing and exiting a trade. Yours may be very different and there is no reason, it should be similar to this

Hope this helps some of you in exploring yourselves and developing a winning strategy ! Mine is not complete by any means and I always am looking for ways to improve it.

I know there might not be anything new for the experienced traders among you. I thank you for reading through the post and I invite readers to comment, commend and criticize this system and offer their viewpoints on the same.

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I have one humble suggestion. If you are recycling old mails, kindly do it with latest (up to date) examples. This will help other members also to watch and learn.

hey

I believe following a trading setup is the most important thing for sucess in markets than which setup you follow..

Just curious ... how well did this strategy work during the period April-Jun this yr . (You must have been in the market then)

Also, do u go entirely by TA, or do u look at Fundanmentals as well ?

AGILENT

Hi Agilent,

Well, I was sitting on cash most part of May - Jun because a lot of stocks were below the 50 and the 200 dma. Made a few profitable trades on Reliance, Praj and Shree Cement post the meltdown. I agree that this strategy would not always work and might also keep you on the sidelines more often than others, but it feels intuitively right because you are not trading against the trend here.

As for the second question, I do like my fundamentals in place before I place a trade, though it is not a hard and fast rule. When I say fundamentals, I generally look at QonQ EPS growth, annual earnings growth. I generally wont exclude stocks only because they have very high P/E. (some pointers I picked up from CANSLIM). This is again a questionable strategy as I have seen some stocks (Mysore Cements) zoom up But I guess it is good to have as many factors on your side as you can , especially when the broad market direction is under doubt.

Ofcourse, I am only learning and you might get a variation of this answer if you talk to me 3 months later. I have learnt a lot from your posts in this forum. Would love to hear what you think about this.

Best Regards,
Ganesh