Selecting a Trade———– Part 1
Just how do we go about finding a great trade?
If you’re getting your trading ideas from friends, your barber or individuals you meet in your everyday life you are up the creek without a bank account.
The next place on the list of worst places to get trading ideas would be free financial chat rooms. Most of these are either the blind leading the blind or a pump and dump scheme.
The blind leading the blind is a room full of neophyte traders (also called green peas) getting ideas from financial websites, magazines, their brokers, etc. Some of these may actually be good trades but nobody in the room knows where the entry, stop loss or exit should be.
The very worst are the penny stock trading rooms. These may be chat rooms, email alerts, newsletters or whatever. The slower the notification system the worse they are.
Penny stocks are worthless stocks. That’s two words. Worth—less. Most often worth less after you buy them. The reason they are a dime or a quarter or even a buck is for a good reason. They don’t have a viable competitive product, terrible management, not enough cash to run the business or a myriad of other fatal business problems.
Yes, occasionally one will take off, but that is attributable to a change in circumstance within the company. If you find one of these before everyone else knows, please let me know and I will join you in that trade.
These are favorites of the pump and dump crowd. If a stock is only a dime a share even someone with only a few hundred bucks in a trading account will buy thousands of shares. Pump and dump is not limited to penny stocks. If you can’t verify a story through normal news channels it’s probably bogus.
If the pumper is highly followed all they have to do is say they bought and everyone else jumps in. Normally they heard a rumor, an employee told them things are about to pop, (blowup???) or as many reasons as you can dream up. Your buys, and hundreds or even thousands of others, drive the price higher, usually very swiftly. While you’re buying the pumper is selling you his shares.
Brokers want you fully invested so they can draw their commissions. Fully invested means all your capital is in the market. They also believe that you cannot time your entries and exits and thus believe you should stay in the market even if the indices fall by 50 % or more. They seem to think that if the market is down 25 % and your account is only down 22 % you are doing well. They also are true believers in a diversified portfolio. Whether you are in an index fund (Dow Jones-S&P-Nasdaq or many others) or in a diversified portfolio (15 to 100’s of stocks) the broker’s primary concern are their commissions.
All this and more before you ever make a trade.
As a value trader I may have eight or ten positions open but there is no relationship to diversification.
In this series of posts I will attempt to explain to you the various factors I am paying attention to as I enter and exit a trade. These will not be real time trades but the entries will have been posted in real time.
3-P/E relative to Market and Sector Performance
4-Strenght of Support / Resistance
5- Market / Trader Sentiment
5-Price Action / Panic- Euphoria
7- Sizing / Quantity
8- Scale in / out
11-Lists / Alerts
I would have liked to make this one post for the 10 separate categories above but at least three or four categories apply to each trade. I will try to make this as simple as possible.
O.K. Let’s take a look at a real trade. Bear in mind that I am a real trader. I make mistakes just like everyone else. The difference in this blog is that you get to see my mistakes. You should learn as much from them as the rest of the blog.
27-Oct-15 06:10 ET
Spirit Airlines beats by $0.03, reports revs in-line; authorizes $100 new share repurchase program (37.87)
- Reports Q3 (Sep) earnings of $1.35 per share, $0.03 better than the Capital IQ Consensus of $1.32; revenues rose 10.6% year/year to $574.8 mln vs the $571.84 mln Capital IQ Consensus.
- Adjusted pre-tax margin for the third quarter 2015 increased 560 basis points to 26.9 percent. On a GAAP basis, pre-tax margin for the third quarter 2015 increased 760 basis points to 26.9 percent.
This is actually a pretty good report. The problem seems to be folks are worried about competition lower the margins. My research tells me Spirit has the best cost structure of all the South American airlines. In my opinion, because of this they will retain their customers. Even with a small compression of the margins their growth will keep their earnings level to slightly higher.
Spirit Airlines (SAVE) has trailing earnings of 4.14 per share with about a 10 percent growth rate. At 34 bucks their trailing P/E (TPE) is 8.2.In a
continually rising market I would have bought this at a 20 P/E, but after our little 2000 plus point correction in the DOW things have changed.
Folks are much more cautious and that translates into lower prices and P/E’s. Now I am looking for a P/E in the 8 to 10 area to see this as a value based trade.
In the 15 minute chart above you see SAVE dropping for two days prior to earnings. The folks were expecting bad news. I have no idea why it dropped after the report. But it gave me the perfect buying opportunity. You would be surprised at how often these opportunities occur.
All this is done in context of the history of the stock and the fundamentals. Take a look at the weekly chart below. SAVE has dropped from the 85 area to 34, a pretty healthy correction. What caused this was a slowdown in their growth two years ago in the mid 20’s to growth in the 10 percent area today.
On the 15 minute chart the circled area shows us panic, capitulation or weak hands getting out of a bad position or whatever you may want to call it. The extreme acceleration and heavy volume is a great indicator of a change in direction for the stock.
In the two days prior to the sudden drop you see a steady decline in prices on the 15 minute chart. I would never (who knows about never) avoid buying any steady decline because it will probably continue for some time.
In the 120 minute chart above you see the fall from 44 to 34. The first two days were leading into earnings and final day where it hit 33.80. The final day is obvious capitulation. This is where a stock changes hands to stronger hands (willing holders). These folks are in at the right level and are much more willing to tolerate a small paper loss on their position because the fundamentals are on their side in this trade. I got in at 34.88 because of a bounce from 34.47 that I mistakenly thought was the bottom since I couldn’t believe it was going this low on that earnings report. The support level was 34.20 and I often see buying pressure build as the stock approaches the support level to the point that it never gets there. I could (should) have added more at 34.20 or lower but felt I was OK in my position at that time.
I sold a quarter of the position at 38.00 for a 3.12 profit and then watched SAVE sink to a new low. Taking a good profit is never a bad thing. You should have a target sell price on a stock before you ever get in a trade. Once you’re in the trade you need to determine where you would like to sell some part of your position. I try to split the sell into 3 or 4 parts. I usually use the resistance levels on the chart or a 10 to 15 percent move.
When SAVE broke to a new low I was hoping (always a good trading strategy-NOT) it would hit the next support level at 32.10 but bottomed out at 32.78. I had orders in at 32.51.
Today SAVE broke through resistance at 36.87 but the 100 SMA (simple moving average) is right above here at 37.26 and will probably stop a further rise for a day or two.
As you can see on the daily chart above I write everything I need to know on the daily and weekly charts so I have no doubt about what I based my decisions on. Being senile does make trading a little harder.
As you can see by this chart patience is definitely a virtue in trading. My ultimate target on this trade is 42.34. It may take 3 or 4 more weeks or even a couple of months before I finally reach my target.
I know that all the lines on the chart are confusing to new traders and even many old hands, but over the years I have found all to be important.
The main function of the weekly chart for me is to give me a historic look back at what the stock has done in the past. Some folks say the past makes no difference but I assure it does in trading.
The other useful tool on the weekly chart is the support and resistance levels. When you are in doubt about the strength of an S/R level compare the levels on a daily and weekly chart. You will find that there are many fewer levels on a weekly chart than there are on a daily chart. I look at the levels on a weekly chart as the stronger levels, much stronger. You can do the same thing with a monthly chart. Those levels there will be stronger than a weekly chart.
I hope this is helpful. Good luck