Books on technical analysis

[tjjeykumar]

STAN WEINSTEIN

Stocks form bottoms when the current news is terrible and top out when the public is ecstatic about glowing earnings reports, stock splits, and so on.

1. Never buy or sell a stock without checking the chart.
2. Never buy a stock when good news comes out, especially if the chart shows a significant advance before the news release.
3. Never buy a stock because it appears cheap after getting smashed. When it sells off further, you’ll find out that cheap can become far cheaper!
4. Never buy a stock in a downtrend on the chart (I’ll soon show you specifically how to define a downtrend).
5. Never hold a stock that is in a downtrend no matter how low the price/earnings ratio. Many weeks later and several points lower, you’ll find out why the stock was going down.
6. Always be consistent. If you find that you’re sometimes buying, and sometimes selling in practically identical situations, then there is something terribly wrong with your discipline.

• Be aware, however, that you can’t become fanatical, as too many technicians often do, when talking about support as being at a certain point. It’s really an area or zone.
• The more times a given support level is tested, and the longer the time period during which the testing takes place, the more important the negative signal that is flashed if that zone is eventually violated.
• 30-week moving average (MA) is the best one for long-term investors, while the 10-week MA is best for traders to use.
• Stocks trading beneath their 30-week MAs should never be considered for purchase, especially if the MA is declining. Stocks trading above their 30-week MAs should never be considered for short selling, especially if the MA is rising. For a long-term investor, the ideal time to buy a stock is when it breaks out above resistance and also moves above its 30-week MA, which must no longer be declining. For a trader the ideal time to buy a stock is when it’s already above its 30-week MA, when the MA is rising. The trader’s ideal entry point is after a stock consolidates in a new trading range and pulls back close to the moving average, then breaks out again above resistance.
• Two hints to always remember are: (1) the longer the time spent below the resistance, the more significant the eventual breakout; and (2) the greater the expansion of volume on the break-out, the more bullish the implications.
• Unlike a breakout, a breakdown doesn’t need a very heavy volume to be valid. Stocks can fall of their own weight, but there should be some increase in volume.
  Pullback. After a stock breaks out of its trading range and advances, there is usually at least one profit-taking correction that brings the price of the stock back close to the initial breakout point . This is an ideal second chance to do further buying (especially if the pullback occurs on sharply decreased volume). On the other hand, after a stock breaks down below support and declines, there is usually at least one pullback back up toward the breakdown level . If this occurs on very light volume, it is an ideal entry point to sell the stock short.
• A significant trendline will be touched at least three times. It’s also important to realize that the greater the slope of a given trendline, the less meaningful its break is on the downside. If you have a very steep advancing trendline , a break below that trendline may merely mean that a stock (or a market average) is now going to move up at a slower rate of advance-
• The most bullish signals are given when a very important trendline is broken on the upside, and within a matter of days the long-term MA is also overcome on the upside. it’s very important that volume is large and expanding on a breakout*
• never buy a stock-no matter how cheap it appears based on fundamentals or a recent sharp decline-if it is trading below its declining 30-'week MA. The price performance is giving you a clear signal that there’s a worm in the apple! Don’t even think of buying it! Conversely, never sell short any stock that is above its rising 30-week MA no matter how high the price/earnings ratio is.
• As long as this line is in a downtrend, don’t consider buying the stock even if it breaks out on the high-low- close price chart.
• watch for those situations where it moves from negative territory (below the zero line) to positive territory. That is another favorable signal.
• Even though they had fallen substantially before their relative-strength line turned negative, once their relative-strength graphs dropped into negative territory, there was far more decline ahead of them.

CHAPTER 2
ONE GLANCE IS WORTH A THOUSAND EARNINGS FORECASTS

• The ideal time to buy is when a stock is finally swinging out of its base into this more dynamic stage. Such a breakout above the top of the resistance zone and the 30-week MA should occur on impressive volume. This is the start of the advancing Stage 2 uptrend phase. However, before the really dynamic part of the advance gets rolling, be aware that there is usually an initial rally followed by at least one pullback. That dip brings the stock back close to the breakout point, which is a good second chance to do low-risk buying.
• Interestingly enough, at the breakout point-which is the perfect time to buy-the reported fundamentals will often be negative.
• this stock is now trading far above its support level and MA and is being discovered by the investment community; it is overextended and most definitely no longer a buy. This is the point where buying puts you at considerable risk.
  From an investing point of view , the right time to buy the stock was either on the initial breakout or on the later pullback toward the breakout level
• how many times I’ve seen portfolios filled with big losses because the entry point for the given stock was poor. Be disciplined! If you are a long-term investor, buy only at the proper entry point early in Stage 2 . If you miss buying a stock, don’t get panicky and chase it and just end up paying any old price. Be consistent. Either buy it right or don’t buy it at all. Obviously a little common sense is needed. With thousands of listed and over-the-counter stocks to pick from, there will always be good stocks at great prices. It’s similar to hailing a taxi; if you miss the first one, another one will soon come along.
• Volume is usually heavy in Stage 3 and the moves are sharp and choppy. If you’ve ever heard the expression that a stock is “churning” (moving sideways on heavy volume), this stage is an outstanding example of it.
• But it’s imperative that you protect your profits on the remaining half position with a protective sell stop set right beneath the bottom of the new support level
• So remember-no matter how powerful the fundamentals, no matter how convincing the story, you are never going to buy a stock in this stage because the reward/risk ratio is strongly stacked against you.
• Unlike an upside breakout, which needs a significant increase in volume to be considered trustworthy, a downside break into Stage 4 doesn’t necessarily need such a huge increase in volume to be considered valid. A volume increase on a breakdown followed by a volume decrease on a pullback to the breakdown point does signal a very dangerous situation; yet I’ve seen many cases where a stock moved into Stage 4 on relatively light volume and dropped substantially in the months ahead.
• At this moment, stop and reflect for a second and then make a pledge to yourself. Take the oath that you are never going to buy another stock in Stage 4. Also promise yourself that you will never hold onto any of your stocks once they move into Stage 4.

CHAPTER 3
THE IDEAL TIME TO BUY

• There are two great times for an investor to do new buying and both center around the breakout point. The first is when a stock initially moves out of its Stage 1 base and enters Stage 2. The second and safer time is when a stock pulls back toward the break- out point after the initial Stage I buying frenzy burns out.
• If you’re a long-term investor, compromise and buy half of your intended position on the initial breakout, and the other half if the stock pulls back close to the breakout price and you like the post-breakout action. I

Equally important, the upside potential is tremendous since the entire Stage ~ advance lies ahead of it. The only drawback is that it can take time for solid Stage 2 momentum to build.

• Volume favorably contracted on the pullback, so then is when you should have bought your remaining half of the position. Thereafter volume increased sharply as it gathered momentum
• very profitable time to do new buying. It occurs after a Stage 2 advance is well underway, when the stock drops back close to its MA and consolidates. It then breaks out anew above the top of its resistance zone. This is called a continuation buy. Again there is a tradeoff involved. In this case the probabilities are overwhelmingly high that the advance will be rapid, but there is a greater risk factor.’ This type of buy is more suited to traders than investors. But investors, too, should be willing to do some late Stage 2 buying when the overall market is very expensive.
• The moving average should be clearly trending higher. This is important! Just as a marathon runner needs something left in reserve for the finish, so does a Stage 2 advancing stock. If the MA starts to roll over and flatten out, you don’t want that stock. Even if it breaks out in a continuation move, it is not likely to have that tiger in its tank that we want. Instead, look for a stock that mimics the outline of this chart and has plenty of high octane power left.
• Although about 80 percent of initial breakouts from a Stage 1 base are followed by a handy pullback, this happens with less than 50 percent of continuation buys. This is especially true if the stock is going to be a grand-slam home run. So the proper tactic when dealing with this type of breakout is to buy your entire position when it overcomes its significant resistance.
  While there are no official rules, I would say as a rule of thumb investors over the years should do about 75 to 80 percent early Stage 2 buying with the remainder coming from continuation moves. Traders, on the other hand, should reverse the figures and do about 80 percent of their buying on breakouts that are already in Stage 2 and have consolidated near the MA before breaking out once again. The rest of a trader’s buying should be of the early Stage 2 variety.
• I’ve always found that my most profitable judgments are made late at night or on weekends.
• What a buy-stop order does is tell the specialist that you want to buy stock XYZ. But-and this is an incredibly important but- only if the stock breaks out above a certain level.
• Using buy-stop orders is very important to your new market strategy.
• Using GTC-stop orders will get you in the habit of doing several positive things. First of all, you won’t have to watch the market closely during the day, which will allow you to concentrate your energies more clearly on your job. Second, you will make far better, less emotional decisions, since they will have nothing to do with that day’s crazy market action.
• sudden strength can cause you to scramble to buy something because it suddenly looks like the market is running away without you. Don’t operate in this manner. It’s crucial that you learn how to properly buy stocks in a disciplined, relaxed way. By using my method of stage analysis and combining it with GTC buy-stop orders, everything will be automatic, which is just what we want to accomplish. Over the years, it has become obvious to me that the more mechanical I’ve made my system and the less
  subject to judgments and emotions, the more profitable it has become.
• In order not to get caught up in the fear-greed syndrome, set time aside each weekend to unemotionally scan your chart publication. You really only need an hour for this chore, but obviously the more time you can spare, the better. Make up a list of the few outstanding potential buys that you see among the many charts. Then, each night, chart and follow these few stocks plus any other issues in your portfolio.
• A very common mistake made by amateur technicians (and, surprisingly, even by some professionals who should know better) is to buy when a stock breaks out above its base even though it is still below its declining 30-week MA.
• Also critical was the fact that the breakout from the trading range occurred below the MA. The fact that the initial breakout took place below the MA was an additional warning sign. It was an even more serious red alert that the MA never stopped heading south. Never buy a stock in this position no matter how cheap it looks.
• you should not have considered buying it for even a moment because the breakout was below the MA

WHAT TO BUY
My “Forest to the Trees” Approach

The place to start this next level of learning is the charts themselves.

When dealing with groups, use the same criteria that you do with stocks. Investors should concentrate their buying in those market areas breaking out of Stage 1 base patterns, while traders should lean toward continuation moves in already existing Stage 2 uptrends.

There is one difference, though.

If the group is already in a well established Stage 2 uptrend and is far above support, an investor wouldn’t normally be in a big hurry to buy that pattern if it was a stock. But if the group is already well into Stage 2 and you find a stock from that sector first breaking out of its Stage 1 base, then it’s fine for an investor to buy that particular stock.

In the same manner, if a trader saw a continuation-pattern buy that looked good in a group that had just moved into Stage 2, the trader can definitely buy that stock. The most important factor when dealing with groups is that the sector be healthy. (That is, not in Stages 3 or 4). All things being equal, however, the very best situation for an investor is a stock that is an early Stage 2 breakout in a group with the exact same pattern. For a trader, the ideal is a continuation breakout within a dynamic group exhibiting the very same sort of pattern.

CHAPTER 4

• REFINING THE BUYING PROCESS

one of the most important is where overhead resistance is situated.

• The message is obvious: always check where and how much resistance is overhead on any stock before you pick up the phone
  to dial your broker with a buy order.

• Never trust a breakout that isn’t accompanied by a significant increase in volume.

• volume should pick up significantly on the breakout. If it doesn’t, the probabilities are very high, it won’t followup.

• Note that there was another bullish signal given on the pullback. Volume contracted by over 75 percent from peak levels.

• we want the market trend to be bullish. Second, the groups should be positive. In addition, the chart from that favorable group must be breaking out into Stage 2 with a minimum of resistance overhead. Finally, volume most definitely must confirm the breakout.

• When you see inferior action in the RS line compared to the price performance, don’t ever buy that stock. Conversely, when you see a very positive relative-strength trend, do not consider shorting it.

• Don’t think, however, that you can never buy a stock below the zero RS line, or that you can never short a stock above the zero line. If the relative strength is in good shape and improving and all other criteria are positive, then go for it. But absolutely never buy a stock, no matter how good the other factors, if the relative strength is in negative territory and it remains in poor shape.

• • Check the major trend of the overall market.
  • Uncover the few groups that look best technically.
  • Make a list of those stocks in the favorable groups that have
  bullish patterns but are now in trading ranges. Write down
  the price that each would need to break out.
  • Narrow down the list. Discard those that have overhead
  resistance nearby.
  • Narrow the list further by checking relative strength.
  • Put in your buy-stop orders for half of your position for those
  few stocks that meet our buying criteria. Use buy-stop orders
  on a good-'til-canceled (GTC) basis.
  • If volume is favorable on the breakout and contracts on the
  decline, buy your other half position on a pullback toward the initial breakout.
  • If the volume pattern is negative (not high enough on break-out), sell the stock on the first rally. If it fails to rally and falls back below the breakout point, immediately dump it.

• The first one is the head-and-shoulder bottom formation. This is the most powerful and reliable of all bottom formations.

• Up until now, rallies that started after a new low was registered failed far below prior peaks.)

• Ideally, the rally peaks (points A and B) will be at the same ap- proximate price, and the two selloffs-on each side of the reverse head-will be approximately equal. But don’t be a fanatic; both the peaks and the two selloffs can be off a bit. Just be sure that there is some semblance of symmetry.

• points A and B on the chart (the first two peaks) should be connected with a trendline that is called the neckline. Keep a close eye on the neckline, because i

• I’ve come to the conclusion that volume is not a good indicator of future upside potential for head-and-shoulder bottoms.
  There are two signals that are important and very reliable. Both are from our system, and neither must ever be ignored. First, make sure that the 30-week MA is in fine shape.
  second important signal is volume after the stock breaks out above the neckline and the MA.
  *** Head-and-shoulder bottom patterns are definitely easier to spot on a daily chart than on a weekly graph. Nevertheless, the really powerful patterns can be picked up even on the weekly chart.

• BIGGER IS BElTER
  There’s an old saying among technicians-“the bigger the base, the bigger the move” (the corollary being, “the bigger the top, the bigger the drop”). I heartily subscribe to that statement. While there are plenty of cases where short-term bases, when mixed with all the other winning ingredients, produce excellent results, always be on the lookout for a breakout from a very large base formation. This is especially important since these formations usually lead to very extensive and long-running advances.
  • Don’t buy when the overall market trend is bearish.
  • Don’t buy a stock in a negative group.
  • Don’t buy a stock below its 30-week MA.
  • Don’t buy a stock that has a declining 30-week MA (even if
  the stock is above the MA).
  • No matter how bullish a stock is, don’t buy it too late in an
  advance, when it is far above the ideal entry point.
  • Don’t buy a stock that has poor volume characteristics on the breakout. If you bought it because you had a buy-stop
  order in, sell it quickly.
  • Don’t buy a stock showing poor relative strength.
  • Don’t buy a stock that has heavy nearby overhead resistance.
  • Don’t guess a bottom. What looks like a bargain can turn
  out to be a very expensive Stage 4 disaster. Instead, buy on breakouts above resistance.

there is the tendency to concentrate on the issues that are acting well and put aside your concern about the laggards, figuring they will come to life later. What happens is that you let the good stocks subsidize the bad ones.
The proper way to look at your stocks is to make believe that each position is the only one you have. If it’s acting fine, great, ride with it. But if it’s lagging badly and acting poorly, lighten up on that position even if the sell-stop isn’t hit. Move the proceeds into a new Stage 2 stock with greater promise.

CHAPTER 5
UNCOVERING EXCEPTIONAL WINNERS

if the chart is bullish but so far above its breakout zone I’d rather miss out on a potential profit any day than buy a stock with a poor reward/ risk ratio. All you’ve lost when you miss a winner is a potential profit. Like buses, another one will come along.

• So discipline and selectivity are operative words to always keep in mind. Remember, we can make really big money in the market even if we pass up 100 winners and buy only 10 stocks during the year, with 7 or 8 turning out to be winners.

• So never believe in any potential takeover that doesn’t show a very significant increase in volume.

CHAPTER 6
WHEN TO SELL

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.

1. Don’t base your selling decision on tax considerations.
   Don’t ever fall into this trap, When a stock turns negative, it’s a sale whether you have a profit or a loss or have to pay taxes. The bloodless verdict of the marketplace doesn’t know what you paid for the stock and doesn’t care. You have to learn to be objective and dispassionate,

2. Don’t base your selling decision on how much the stock is yielding.

3. Don’t hold onto a stock because the price-earnings (PE) ratio is low.

4. Don’t sell a stock simply because the P/E is too high.

5. Don’t average down in a negative situation.

6. Don’t refuse to sell because the overall market trend is bullish.

7. Don’t wait for the next rally to sell. When the chart pattern signals that a stock is running into trouble, get out immediately. Don’t wait around trying to recoup an extra point or two on a rally.

8. Don’t hold onto a stock simply because it is of high quality.

SELLING PROPERLY-THE INVESTOR’S WAY

When you set your initial stop, pay less attention to the MA and more to the prior correction low.

If the sell-stop should be placed right above a round number, or on it, set it instead just under the round number.

try to limit your purchases to those cases where the initial stop isn’t greater than 15 percent below your purchase price.

As long as the stock is above its rising 30-week MA, and the MA is rising in Stage 2 fashion, be sure to give it plenty of room to gyrate.

Therefore, once a stock moves into this higher risk zone you should become more aggres- sive with your sell-stop that means moving the stop under the correction low at point K even though it is above the MA.

As long as the MA is sloping upward at a sharp angle of ascent, investors should be sure to give a stock some leeway.

As long as the MA is sloping upward at a sharp angle of ascent, investors should be sure to give a stock plenty of room when placing the stop. But once the MA starts to level out and a potential Stage 3 top begins to unfold, it is time to pull the sell-stop up tighter.

Even if the stock slightly penetrates the MA along the way, you can still stay with it. However, this is only true if two important criteria are met. First, the MA must still be rising. And second, the prior correction low must not be violated.

clear-cut trendline is one that connects at least three points.

CHAPTER 10
PUTTING IT ALL TOGETHER

Promise yourself that you absolutely will never again buy a stock in Stage 4 no matter how exciting the story. Also swear that you’ll never hold onto a declining Stage 4 stock no matter what rumors come your way.

1. Check the market indicators for overall direction.
2. Scan the groups so you’ll know which ones to zero in on.
3. Cull out those few stocks with the most potentially profitable formation within those favorable groups.
   Once you’ve taken these steps, here are some rules to follow:
   • If you’re an investor, do most of your buying early in Stage 2, when major bases are being completed.
   • If you’re a trader, concentrate the majority of your buying in continuation-type buy patterns that are already in Stage 2.
   • Before entering your buy order, make sure you know where your protective sell-stop will be set. If it’s too far away from the purchase price, look for a new buy or wait to purchase the stock when a safer stop level forms. The converse is true when selling short.
   • Never sell a stock that’s in Stages 1 or 2 (especially Stage 2).
   • Never buy a stock that’s in Stage 3 or 4 (especially Stage 4).
   • Never hold a long or short without a protective stop.

• Never guess a bottom. Learn the important lesson that it’s better to be late and buy in Stage 2, than to grab a stock that looks cheap but will be 40 to 50 percent cheaper later in Stage 4.

But if upon later examination you realize that either the volume was inadequate, or the relative strength was lacking, or the group was negative, or you were influenced by a rumor, write down that error. After several months look for a common denominator in your losses. We all have psychological patterns. When you see what your particular destructive pattern is, it will be easy for you to retrain yourself and deal with it so your investing will become even more profitable.

[LarryWink]

Jey Ji
Thanks for the quotes.
The question is how do we screen names which are in stage 2 or stage 3?
Is it possible to write a script at screener.in, the only screening tool i can think of now, or any other ?

[tjjeykumar]

Hi Larry Wink, Good to know that you find it useful. Nothing beats manually scanning your watchlist of stocks. One other shortcut is to look for stocks in high volume trade watchlist. In this we can scan those names which fit in the stage 2 breakout along with RS line pattern

[tjjeykumar]

MARK MINERVINI QUOTES

My goal is not to buy at the lowest or cheapest price but at the “right” price, just as the stock is ready to move significantly higher. Trying to pick a bottom is unnecessary and a waste of time; it misses the whole point.

Transition from Stage 1 to Stage 2

There should always be a previous rally with an escalation in price of at least 25 to 30 percent off the 52-week low before you conclude that a stage 2 advance is underway and consider buying.
The 150-day moving average is above the 200-day moving average, and the stock is trading above both the 150-day and 200-day moving average during the markup phase. Note, too, the surging volume on the rallies, contrasted with lighter volume on pullbacks.

This would be the point at which I would start to consider a new purchase; any earlier lacks confirmation and is premature, meaning you run the risk of being stuck in dead money. Most amateurs would think the stock is too high and wish they had bought it when it was lower, using hindsight as a guide. That’s why most amateurs don’t make big money in stocks.

Stage 3—The Topping Phase: Distribution

Stage 3 Characteristics

Volatility increases, with the stock moving back and forth in wider, looser swings. Although the overall price pattern may look similar to stage 2, with the stock moving higher, the price movement is much more erratic.
There is usually a major price break in the stock on an increase in volume. Often, it’s the largest one-day decline since the beginning of the stage 2 advance. On a weekly chart, the stock may put in the largest weekly decline since the beginning of the move. These price breaks almost always occur on overwhelming volume.
The stock price may undercut its 200-day moving average. Price volatility around the 200-day (40-week) moving average line is common as many stocks in stage 3 bounce below and above the 200-day average several times while topping out.
The 200-day moving average will lose upside momentum, flatten out, and then roll over into a downtrend.

How to Pinpoint Stage 2

The Trend Template is a qualifier. If a stock doesn’t meet the Trend Template criteria, I don’t consider it. Even if the fundamentals are compelling, the stock must be in a long-term uptrend—as defined by the Trend Template—for me to consider it as a candidate.

Trend Template

1. The current stock price is above both the 150-day (30-week) and the 200-day (40-week) moving average price lines.
2. The 150-day moving average is above the 200-day moving average.
3. The 200-day moving average line is trending up for at least 1 month (preferably 4–5 months minimum in most cases).
4. The 50-day (10-week) moving average is above both the 150-day and 200-day moving averages.
5. The current stock price is trading above the 50-day moving average.
6. The current stock price is at least 30 percent above its 52-week low. (Many of the best selections will be 100 percent, 300 percent, or greater above their 52-week low before they emerge from a solid consolidation period and mount a large scale advance.)
7. The current stock price is within at least 25 percent of its 52-week high (the closer to a new high the better).
8. The relative strength ranking (as reported in Investor’s Business Daily) is no less than 70, and preferably in the 80s or 90s, which will generally be the case with the better selections.

Bases 1 and 2 generally come off a market correction, which is the best time for jumping on board a new trend. As the stock makes a series of bases along the stage 2 uptrend, base 3 is a little more obvious but usually still tradable. By the time a fourth or fifth base occurs (if it gets that far), the trend is becoming extremely obvious and is definitely in its late stages. By this point, abrupt base failures occur more frequently.

base counting will not tell you if a stock has topped or is about to move substantially higher. It does, however, provide a great way to gain perspective on where you are within the stage 2 advance.

The goal is not to buy at the cheapest price but to sell your stock for significantly more than the price you paid in the shortest period. That’s how superperformance is achieved.

If your stock experiences its largest daily and/or weekly price decline since the beginning of the stage 2 advance, this is a sell signal in most cases even if it comes on the heels of a seemingly great earnings report.

Many times before a fundamental problem is evident, there will be a hint in the form of a material change in price behavior. That change should always be respected even if you don’t see any reason for the sudden change in sentiment. Earnings may still look good. The story may still be intact. However, in most cases, you’ll be far better off getting out—shooting first and asking questions later—than waiting to learn the reason why. When a stock that had been in a strong stage 2 suddenly goes into a stage 3 topping pattern or transitions quickly into stage 4, don’t sit there and assume that everything is fine.

Let the Wind Fill Your Sails
As we’ve discussed in this chapter, to achieve superperformance, you need the powerful force of institutional buyers on your side to propel your stock’s price sharply higher. A proper stage 2 uptrend provides evidence that institutions are indeed stepping up to the plate, just as a stage 4 decline clearly demonstrates the opposite.

You want to see same-store sales increasing each quarter. High-single-digit to moderate-double-digit same-store sales growth is high enough to be considered robust but not so high that it’s unsustainable (25 to 30 percent or more same-store sales growth is definitely unsustainable over the long term)

Interestingly, cyclical stocks have an inverse P/E cycle, meaning they generally have a high P/E ratio when they are poised to rally and a low P/E near the end of their cycle.

Inventories and supply and demand are important variables in analyzing the dynamics of cyclical stocks. When the P/E ratios of cyclical stocks are very low after earnings have been on the rise for many months or several years, it’s often a sign that they’re near the end of their up cycle. When P/Es are superhigh and you’ve heard nothing but doom and gloom about the company or industry for an extended period, the bottom may be near.

Specific Industry Groups Lead New Bull Markets
The formation of a bear market bottom typically begins with signs of accumulation in certain market sectors or segments.

How do you find which groups are leading? Follow the individual stocks. I like to track the 52-week new high list. The industry groups with a healthy number of stocks hitting new highs early in a bull market will often be the leaders. Your portfolio should consist of the best companies in the top four or five sectors.

Buying into the leading areas early in a bull market can lead to significant capital gains. Some groups start emerging late in a bull cycle and can lead during the next upturn after a bear market. It’s definitely worth investigating the industry groups in which most stocks were resisting the decline and then subsequently broke into new highs while the market was coming off its lows or during the market’s initial few rallies.
The top relative strength leaders in these groups typically lead their group’s advance from the beginning and are likely to show the greatest appreciation. When you see a growing number of names in a particular industry making new 52-week highs (especially coming off a market low), this could be an indication that a group advance is underway.

I have found that more often than not, the best stocks in the leading groups advance before it’s obvious that the group or sector is hot. Therefore, I focus on stocks and let them point me to the group.

If a company has posted very good quarterly results that are much better than were anticipated by analysts, there are probably more good quarters ahead. If a company is performing well with earnings surprises, other companies in the same industry or sector may post some upside surprises as well.

Because earnings surprises have a lingering effect, we want to focus on companies that beat estimates and avoid firms that have negative earnings surprises. One way to find candidates is to check to see if earnings reported in the last couple of quarters were better than expected.

Look for companies for which analysts are raising estimates. Quarterly as well as current fiscal year estimates should be trending higher; the bigger the estimate revisions, the better.

Really successful companies generally report earnings increases of 30 to 40 percent or more during their superperformance phase.

The ideal situation is when a company has higher sales volume with new and current products in new and existing markets as well as higher prices and reduced costs. That’s a winning combination.

The best kind of margin improvement comes from pricing power because of strong demand for a company’s products.

common for stocks to sell off on profit taking after a big rally and decline on news, a superperformance stock will come back and resume its advance. For a true superperformer, there should definitely not be a huge sell-off that breaks the whole leg of the stock’s upward move.
After a company reports its earnings, my focus turns to the postearnings drift (PED), which suggests that it may not be too late to buy a stock after it has reported better than expected earnings. Even if you miss the first upward reaction after results are reported, the postearnings drift after a significant surprise can last for some time. Stock price movements from significant earnings surprises not only are felt right way but can have a longer-term effect beyond the immediate price adjustments. Many studies have shown that the effect can persist for months after an earnings announcement.

How do you know what the market wants other than the published estimates? Study how the stock price responds. Was the stock rewarded or punished when the results came in? Was an upside surprise big enough to move share prices higher, or did the stock sell off? Even if an earnings report appears to be a surprise, you can judge the true perception only from the response of the share price. Unexpected surprises can have a dramatic effect better than expected earnings along with positive earnings guidance. A company should not only be doing well but be doing better than analysts anticipate.

In some cases, the reaction to earnings guidance is stronger than the reaction to the actual earnings report when it is announced. By tracking what a company says and then what develops later on, you can ascertain the quality and tendencies of the company’s guidance.

In dealing with future earnings, it’s important not to look too far out. Growth investors tend to have a “what have you done for me lately” mentality. Therefore, focus on what the company is saying about the upcoming quarter and the current fiscal year. My rule of thumb is to take long-term forecasts with a grain of salt. No one, not even management, can accurately forecast what a company will earn or what its rate of growth will be a year or two down the road. If they say, “Business conditions will be tough this year, but we see improvement coming next year,” that’s not positive guidance. That’s spin.

The best situation for rapid earnings growth is to be hitting on all cylinders as sales accelerate and profit margins expand simultaneously.
Look for what I call a Code 33 situation, three quarters of acceleration in earnings, sales, and profit margins. That’s a potent recipe.

As a bull market enters its later stages (generally after one or two years), many of the leadership stocks that led the market advance will start to buckle while the broad market averages march on toward their tops. Typically, a second wave of postleadership stocks start to perform relatively well as money rotates out of the true leaders and into some of the group’s constituents, laggard follow-up stocks, or defensive groups such as drugs, tobacco, utilities, and food stocks that are thought to be less sensitive to an economic downturn. Follow-on stocks and laggards, however, rarely experience the length or, more important, the magnitude of the price move that true market leaders accomplish. When you see this rotation occurring, it’s a warning that the market rally may be entering its later stage. The ultimate market top may still be weeks or even months away, but this internal market action is a proverbial shot across the bow that should get your attention.

After a market correction, many investors are busy hoping to break even on the open losses they hold or are convinced that the end of the world is coming because they got crushed during the previous decline and refuse to acknowledge the buy signals individual leading stocks are offering.
Making it even more difficult is the fact that leading stocks always appear to be too high or too expensive to most investors. Market leaders are the stocks that emerge first and hit the 52-week-high list just as the market is starting to turn up. Few investors buy stocks near new highs, and fewer buy them at the correct time. They focus on the market instead of the individual market leaders and often end up buying late and owning laggards. Adding to the distraction is the fact that the news media are usually wrong at major turning points. At a market bottom they’ll predict the end of the world, and at a top the same people will say you can’t go wrong investing in stocks.

More than 90 percent of superperformance stocks emerge from bear markets and general market corrections. The key is to do your homework while the market is down; then you will be prepared to make big profits when it turns up.

Many inexperienced investors will be looking to buy a pullback that rarely materializes during the initial leg of a new powerful bull market, which from the onset will appear to be overbought.
Typically, the early phase of a move off an important bottom has the characteristics of a lockout rally. During this lockout period, investors wait for an opportunity to enter the market on a pullback, but that pullback never comes. Instead, demand is so strong that the market moves steadily higher, ignoring overbought readings. As a result, investors are essentially locked out of the market. If the major market indexes ignore an extremely overbought condition after a bear market decline and your list of leaders expands, this should be viewed as a sign of strength. To determine if the rally is real, up days should be accompanied by increased volume whereas down days or pullbacks have lower overall market volume. More important, the price action of leading stocks should be studied to determine if there are stocks emerging from sound, buyable bases.

In the early stages of a market-bottom rally it’s absolutely critical to focus on leading stocks if your goal is to latch on to big winners. Sometimes you will be early. Stick with a stop-loss discipline, and if the rally is for real, the majority of the leading stocks will hold up well and you will have to make only a few adjustments. However, if you get stopped out repeatedly, you may be too early.
The Best Stocks Make Their Lows First
To make big money in the stock market, you’re going to need to have the overall stock market’s primary trend on your side. A strong market trend is not something you want to go against. However, if you concentrate on the general market solely for timing your individual stock purchases, you’re likely to miss many of the really great selections as they emerge at or close to a market bottom.
The true market leaders will show strong relative price strength before they advance. Such stocks have low correlation with the general market averages and very often act as lone wolves during their biggest advancing stage.

Although it’s true that many of the market’s biggest winners are part of industry group moves, in my experience, often by the time it’s obvious that the underlying sector is hot, the real industry leaders—the very best of the breed—have already moved up dramatically in price.

By applying a bottom-up approach to find the best relative performers in the early stages of a bull market, you will put yourself in a position to latch
on to some really big winners. The stocks that hold up the best and rally into new high ground off the market low during the first 4 to 8 weeks of a new bull market are the true market leaders, capable of advancing significantly. You can’t afford to ignore these golden opportunities

Market leaders tend to stand out best during an intermediate market correction or in the later stages of a bear market. Look for resilient stocks that hold up the best, rebound the fastest, and gain the most percentage- wise off the general market bottom. This, too, will identify potential leading names. After an extended bear market correction, look for stocks that hold their ground or, even better, work their way higher while the general market averages trend lower. A series of higher lows during lower lows in the general averages is a tip-off that a potential market leader is in the making. The relative strength line of the stock should show steady improvement as the market declines. It’s important to study carefully the price action of individual companies with new positive developments and strong earnings per share during major market declines. Many of the most strongly rebounding stocks and the ones that hold up the best are likely to become the next up cycle’s superperformers.

Volume on the major averages should also be watched for signs of distribution. If this is accompanied by increasing volume on down days versus up days, it may be too early, and you may need to revert back to cash for protection.

Which Leaders Should I Buy First?
As you shift into buying gear, the question becomes, Which stocks should I buy first? It’s simple. Buy the strongest first. Coming off a market low, I like to buy in order of breakout. The best selections in your lineup will be the first to burst forth and emerge from a proper buy point and into new high ground. The ones that act the strongest are generally the best choices at this point. Let the strength of the market tell you where to put your money, not your personal opinion, which rarely is a good substitute for the wisdom of the market. Ultimately, opinions mean nothing compared with the verdict of the market. The stocks that emerge first in the early stage of a new bull market with the greatest power are generally the best candidates for superperformance.

When a market is bottoming, the best stocks make their lows ahead of the absolute low in the market averages. As the broader market averages make lower lows during the last leg down, the leaders diverge and make higher lows. It’s important to watch very carefully at this juncture and stand ready to cut your losses if volatility widens too much in your individual holdings. If more leaders emerge and the overall market strengthens, be ready move to an even more aggressive long bias.

A Double-Edged Sword
Just as the leaders lead on the upside, they also lead on the downside. Why? After an extended rally or bull market, the market’s true leaders have already made their big moves. The smart money that moved into those stocks ahead of the curve will move out swiftly at the first hint of slowing growth. When the leading names in leading industry groups start to falter after an extended market run, this is a danger signal that should heighten your attention to the more specific signs of market trouble or possible trouble in a particular sector.
Most stocks experience a relatively severe decline in price after a super- performance phase has run its course. This is due to profit taking and the anticipation of slower growth ahead. Scientific evidence and my personal experience indicate that the chances of a superperformer giving back most or all of its gains are high. You must have a plan to sell and nail down profits when you have them. History shows that one-third of super performers give back all or more of their entire advance. On average, their subsequent price declines are 50 to 70 percent, depending on the period measured.

Bull markets sometimes roll over gradually, whereas bottoms often end with a sudden sell-off, followed by a strong rally. As the leaders start to buckle, the indexes can move up farther or start to churn, moving sideways. That occurs because cash stays in the market and rotates into laggard stocks. The indexes hold up or even track higher on the backs of the stragglers. Watch out! When this happens, the end is near and the really great opportunities may have already passed.

you should concentrate on the new 52-week-high list. Many of the market’s biggest winners will be on the list in the early stages of a new bull market. You should also keep an eye on stocks that held up well during the market’s decline and are within striking distance (5 to 15 per- cent) of a new 52-week high.

A common characteristic of virtually all constructive price structures (those under accumulation) is a contraction of volatility accompanied by specific areas in the base structure where volume contracts significantly.

I want to see the stock move from greater volatility on the left side of the price base to lesser volatility on the right side.

The progressive reduction in price volatility, which will be accompanied by a reduction in volume at particular points, eventually signifies that the base has been completed.

line of least resistance. Tightness in price from absolute highs to lows and tight closes with little change in price from one day to the next and also from one week to the next are generally constructive. These tight areas should be accompanied by a significant decrease in trading volume.

A significant contraction in volume associated with tightness in price signals supply has stopped coming to market and the line of least resistance has been established.

If the stock’s price and volume don’t quiet down on the right side of the consolidation, chances are that supply is still coming to market and the stock is too risky.

I rarely buy a stock that has corrected 60 percent or more; a stock that is down that much often signals a serious problem. Most constructive set- ups correct between 10 percent and 35 percent.You will have more success if you concentrate on stocks that correct the least versus the ones that correct the most. Under most conditions, stocks that correct more than two or three times the decline of the general market should be avoided.

By demanding that the price action display VCP characteristics, you will increase your chances of identifying a stock in which supply is diminishing and a sound point for entry is developing, which will lead to an immediate and sustained advance.

Avoid a stock that follows a big demand day with even bigger down days on volume. Large up days and weeks on increased overall volume, contrasted with lower-volume pullbacks, are another constructive sign that the stock you are considering is under institutional accumulation. Look for these traits before you buy.

Price Spikes Preceding a Consolidation
Often a price spike will occur on the left side just before a price correction or consolidation begins.

Jesse Livermore described the pivot point as the line of least resistance. A stock can move very fast once it crosses this threshold. When a stock breaks through the line of least resistance, the chances are greatest that it will move higher in a short period of time. This is the case because this point represents an area where supply is low; therefore, even a small amount of demand can move the stock higher. Rarely does a correct pivot point fail coming out of a sound consolidation.

During the tightest section of the consolidation (the pivot point), volume should contract significantly.

Now, just as the price breaks above the pivot on increasing volume, that’s where you want to place your buy order.

Extrapolating Volume Intraday
After the last narrow contraction in a VCP pattern on light volume, ideally you want to see an upward move in the making on stronger than usual volume. Let’s say that a stock normally trades 1 million shares. Two hours into the trading day, 500,000 shares—half the usual volume—has already exchanged hands and the stock is moving up. You still have four and a half hours to go. Therefore, you can comfortably extrapolate that on the basis of the intraday volume thus far, the volume for the day could easily be 300 to 400 percent (or more) of the average daily volume. Now, when the price goes through the pivot point, you can place your trade.

If the pivot point is tight, there is no material advantage in getting in early; you will accomplish little except to take on unnecessary risk. Let the stock break above the pivot and prove itself.

Once the stock successfully breaks out, the stock price should hold its 20-day moving average and in most cases should not close below it.

Don’t buy just because a trendline is breached; wait for the stock to turn. The spot to begin buying is just as the high of the pause is taken out. This could occur at the cheat area or the handle.

Regardless of your methodology or approach to stock investing, there is only one way to protect your portfolio from a large loss, and that is to sell when you have a small loss before it snowballs into a huge one. In three decades of trading, I have not found a better way.

Avoiding large losses is the single most important factor for winning big as a speculator. You can’t control how much a stock rises, but in most cases, whether you take a small loss or a big loss is entirely your choice.

Every major correction begins as a minor reaction. You can’t tell when a 10 percent decline is the beginning of a 50 percent decline until after the fact, when it’s too late.

When fundamental problems arise in a public company, management is probably your worst source of information.

Your goal is not risk avoidance but risk management: to mitigate risk and have a significant degree of control over the possibility and amount of loss.

The Initial Stop-Loss
Before buying a stock, I establish in advance a maximum stop loss: the price at which I will exit the position if it moves against me. The moment the price hits the stop loss, I sell the position without hesitation.

You shouldn’t assume that a stock will reset if it moves against you. You should always protect yourself and cut your loss. However, if a stock knocks you out of your position, don’t automatically discard it as a future buy candidate. If the stock still has all the characteristics of a potential winner, look for a reentry point. Your timing may have been off. It could take two or even three tries to catch a big winner. This is a trait of professional traders. Amateurs are scared of positions that stop them out once or twice or just weary of the struggle; professionals are objective and dispassionate.

Selling into strength is a learned practice of professional traders. It’s important to recognize when a stock is running up rapidly and may be exhausting itself. You can unload your position easily when buyers are plentiful. Or you could sell into the first signs of weakness immediately after such a price run has broken down. You need to have a plan for both selling into strength and selling into weakness.

The importance contingency planning plays is that it enables you to make good decisions when you’re under fire, when you need it the most.

very important rule: always keep your risk at a level that is less than that of your average gain.
At What Point Should You Cut a Loss?

A rule of thumb could be to cut your losses at a level of one-half of your average gain.

Avoid the Trader’s Cardinal Sin
Allowing your loss on a trade to exceed your average gain is what I call the trader’s cardinal sin.

if your winning trades produce a gain of 15 percent on average, you should sell any declining stock at no more than 7.5 percent off the purchase price.

If you can’t time a purchase well enough that you need more than 10 percent fluctuation from your point of purchase, something is wrong with your timing and selection criteria.

In my experience, a 10 percent decline signals that something is wrong with the trade, assuming that you purchased it correctly in the first place.

Always Determine Your Risk in Advance
The time to think most clearly about where you will exit a position is before you get in. By the time you purchase a stock, the price at which you will sell at a loss should already be determined. When a stock drops to your defensive sell line, there is no time for vacillating or second-guessing. There is no decision to be made; it’s been decided ahead of time. You just carry out your plan; you should write down your sell price before you buy each stock.

Not defining and committing to a predetermined level of risk cost traders and investors more money than any other mistake.

Most investors can’t stand to take losses. Unfortunately, as a result, they suffer much bigger losses that do lasting damage to their portfolios. This is ironic;

Sooner or later, however, one of your stocks will dive under your sell price before you can react; this is called slippage. My advice is to get out immediately. Take whatever the next bid price is. Such a hard-falling stock is sending a warning.

How to Handle a Losing Streak
A losing streak usually means it’s time for an assessment. If you find yourself getting stopped out of your positions over and over, there can only be two things wrong:

1. Your stock selection criteria are flawed.

2. The general market environment is hostile.

Leading stocks often break down before the general market declines. If you’re using sound criteria with regard to fundamentals and timing, your stock picks should work for you, but if the market is entering a correction or a bear market, even good selection criteria can show poor results.

If you’re experiencing a heavy number of losses in a strong market, maybe your timing is off.

By pyramiding up when you’re trading well and tapering off when you’re trading poorly, you trade your largest when trading your best and trade your smallest when trading your worst. This is how you make big money as well as protect yourself from disaster

In my trading, I try to buy or add to a position in the direction of the trade only after it has shown me a profit; even if I’m buying a pullback, I generally wait for the stock to turn up before going long. The lesson: never trust the first price unless the position shows you a profit.

Move your stop up when your stock rises by two or three times your risk, especially if that number is above your historical average gain.

Depending on the size of your portfolio and your risk tolerance, you should typically have between 4 and 6 stocks, and for large portfolios maybe as many as 10 or 12 stocks.

[tjjeykumar]

THINK AND TRADE LIKE A CHAMPION

A TALE OF TWO WOLVES
There are two types of traders inside you and me and everyone. One I call the builder—disciplined and process-driven. The builder is focused on procedure and perfecting the method. The builder trusts that the results will come if he gets the process right. Mistakes are viewed as teachers, constantly providing valuable lessons in a continuous feedback loop. When the builder makes a mistake, it’s taken as encouragement: That’s one I won’t make again. Ever optimistic, the builder looks forward to the day when results are achieved— good or bad—because the process is constantly being improved.
The other trader is what I call the wrecking ball. Ego-driven, the wrecking ball is fixated on results; if they don’t come right away, he gets discouraged. If a mistake is made, the wrecking ball beats up on himself or looks for someone or something else to blame. If a strategy doesn’t produce winning results quickly or it goes through a difficult period, the wrecking ball tosses it aside and looks for a new strategy, never really committing to the process. A

wrecking ball, as you might guess, has tons of excuses and rarely takes ownership of the outcome—and as a result, never builds anything lasting or wonderful.

The one that wins will be the one I choose to feed.’

It’s not just putting in the hours that will make you successful; it’s the persistent intention to improve by examining your results, tweaking your approach, and making incremental progress. In his book The Talent Code, Daniel Coyle refers to this process as “deep practice”—not just doing the same thing over and over, but using feedback to make adjustments and making practice more meaningful.

If you spread yourself too thin, you won’t succeed big at anything and will never experience anything fully. Specialists get paid well, while those who know a little about many things make good conversation at parties.
Mastery requires sacrifices; therefore, something must come first. Make a list, prioritize, and pursue accordingly: Focus, achieve, and then move to the next big goal.

Through those challenging years, though, I stuck with my strategy. I didn’t jump from one approach to another as if there were some magic formula out there and the secret was finding it. As stated earlier, I decided on a strategy
that made sense to me and then concentrated on improving my ability to execute it. I stayed the course, remained steadfastly disciplined, and stuck to the rules. Persistence is more important than knowledge, and victory comes to those who persist, as long as you are learning from your experiences.

The first thing I would like to see after a breakout from a base is multiple days of follow-through action, the more the better. The best trades emerge and rally for several days on increased volume. This is how you differentiate institutional buying from retail buying.

Stocks under strong institutional accumulation almost always find support during the first few pullbacks over the course of several days to a couple of weeks after emerging from a sound structure.

The best stocks usually rebound the fastest. Once I buy a stock, if it meets my upside expectations very quickly and displays tennis ball action, I will probably hold it longer.

trade is working out as planned is more up days than down days during the first week or two of a rally. I simply count the days up and the days down; the more up days the better. I want to see three up days out of four, or six up days out of eight —ideally seven or eight up days in a row. Stocks under institutional accumulation almost always display this type of price action, which is evidence that institutions are establishing big positions that can’t be filled in only one day.

Big winning stocks will display the following characteristics:
Follow-through price action after a breakout
More up days than down days and more up weeks than down weeks Tennis ball action—resilient price snapback after a pullback
Strong volume on up days and up weeks compared to down days and down weeks
More good closes than bad closes.

IF THINGS DON’T GO AS PLANNED

WATCH THE 20-DAY LINE SOON AFTER A BASE BREAKOUT
Once a stock breaks out of a proper base and starts moving up, it should hold above its 20-day moving average; I don’t want to see the price close below its 20-day line soon after a breakout. If that happens, it’s a negative.

Three lower lows on increased volume is a red flag

Sometimes it takes four lower lows. The rule of thumb, however, is every consecutive lower low after the third becomes more and more ominous, and even much more so if volume is high.

LOW VOLUME OUT, HIGH VOLUME IN IS A BIG WARNING

If a stock breaks out on low volume and then comes right back in on high volume on subsequent days, that’s a real reason for concern

Depending upon how many violations occur and how severe they are, I’ll either reduce my position or get out entirely. Of course, if my stop-loss is hit, then I’m out regardless!

Violations Soon After a Breakout
Low volume out of a base—high volume back in Three or four lower lows without supportive action More down days than up days
More bad closes than good closes
A close below the 20-day moving average
A close below the 50-day moving average on heavy volume Full retracement of a good-size gain.

After you make a purchase, try to give the stock a week or two and enough room to fluctuate normally—within the confines of your stop level, of course. If the stock squats, don’t panic; as long as your stop is not triggered and no major violations occur, wait to see if the stock can stage a reversal recovery.

You go in with a plan and execute it. Then, after the trade is completed, you evaluate the results, troubleshoot your approach, and come back in with a new plan of attack.

With each buy order I enter, I know the exact price where I am going to sell at a loss if things don’t work out as expected. I define this price level before I get in.

My stop-loss is actually an important part of my selection process. I may set my sights on a particular name, but I’m not going to buy a stock unless it offers me a low-risk entry point. You don’t control risk when you sell, you control it when you buy;

Buying breakouts and setting stops based on a percentage drop is a good start and will likely put you ahead of most traders.

The goal for optimal stop-loss placement is to set it at a level that will allow the stock price enough room for normal fluctuation, but close enough to the danger point that’s not too much risk mathematically.

always go in with a plan and approach every trade risk-first.

In order to set an appropriate stop-loss, you need to know your average gain, not just what you hope to make on each individual trade, but a number you can reasonably expect to occur over time on average.

My way of governing the areas that I don’t directly control is not to rely on them too heavily. My edge is maintained by keeping my losses at a fraction of my gains. The smaller I keep my losses in relation to my gains, the more batting average risk I can tolerate, which means the more times I can be wrong and still make money.

If you’re trading poorly and your batting average falls below the 50 percent level, the last thing you want to do is increase the room you give your stocks on the downside.

My results went from average to stellar when I finally made the choice that I was going to make every trade an intelligent risk/reward decision. The following formula is the only holy grail I know of:
PWT (percentage of winning trades)*AG (average gain) / PLT (percentage of losing trades)*AL (average loss) = Expectancy

Any stock that rises to a multiple of my stop-loss and is above my average gain should never be allowed to go into the loss column. When the price of a stock I own rises by three times my risk and my gain is higher than my average, I almost always move my stop up to at least breakeven.

Move your stop up when your stock rises by two or three times your risk, particularly if that number is above your historical average gain

three legs of the trading triangle are:
Your average win size: how much do you win, on a percentage basis, across all your winning trades?
Your average loss size: how much do you lose, on a percentage basis, across all your losing trades?
Your ratio of wins to losses: your percentage of winning trades, or what is referred to as your “batting average.”

The next relevant numbers are the largest gain and loss in any one month and the number of days my gains and losses are held. I call them the “Stubborn Trader” indicators. Don’t pay much attention to any one month, but when you look at the average over a 6- to 12-month period, the net result should be positive. For example, if your largest gainers are smaller than your largest losers on average, this means you’re stubbornly holding losses and only taking small profits, the exact opposite of what you should be doing. If your average hold time on your gainers is less than the amount of time you hold your losers, again, it’s an indication that you hold onto losses and sell winners too quickly.

If you’re turning your portfolio over very rapidly, you can have smaller gains and losses and a lower win/loss ratio than if you’re turning it over less. You’re getting the benefit of your “edge” more often. This is the same concept as a retailer who sells a low-priced or low-margin

Remember, trading is not about buying at the absolute low and selling at the all-time high. It’s about buying lower than you sell, making profits that are larger than your losses, and doing it over and over again.

Using this example, if you sell half your position at 20 percent, compared to your average gain of 10 percent, it’s very difficult to lose on the trade. Half of your trade is booked at a 20 percent profit. Even if you only break even on the remaining half, you will still make 10 percent (right in line with your

average gain), and you’ll still be ahead of the game. In fact, you could suffer a 10 percent loss on the remaining position and still be okay with no loss on the trade.

One word of caution—selling half does not work on the downside when you’re at a loss. When your stop is hit, you get out! You shouldn’t sell half on the downside and gamble with the rest of your position, hoping the stock will turn around. When a position moves against you and hits your defensive sell line, there is no wiggle room—only disciplined, decisive action.

a secular market leader puts in a major top, there’s a 50 percent chance that it will decline by 80 percent—and an 80 percent chance it will decline by 50 percent.

Every major decline starts as a minor pullback. If you have the discipline to heed sound trading rules, you will limit your losses while they’re small and you will not throw good money after bad.

Pros play the percentages; they’re consistent, and they avoid the big errors. Most of all, they avoid risking money on low probability plays. They bet when the odds are in their favor and fold when they’re not.

1. Protect myself from a large loss with an initial stop
2. Protect my principal once the stock moves up
3. Protect my profit once I’m at a decent gain
   I have some general guidelines: Any stock that rises to a multiple of my stop-loss and above my average gain should never be allowed to go into the loss column. When the price of a stock I own rises by three times my risk, I almost always move my stop up, especially if that number is above my historical average gain. If a stock rises to twice my average gain, I always move my stop up to at least breakeven, and in most cases I back stop the position equal to my average gain.

My general rule of thumb is never hold a large position going into a major report unless I have a reasonable profit cushion.

Regardless of how well you know the company, holding into earnings is always a crapshoot.

One of my major rules is never force trades.

TREND TEMPLATE CRITERIA
A stock must meet all eight criteria to be deemed in a confirmed Stage 2 uptrend.
1. Stock price is above both the 150-day (30-week) and the 200-day (40- week) moving average price lines.
2. The 150-day moving average is above the 200-day moving average.
3. The 200-day moving average line is trending up for at least 1-month
(preferably 4 to 5 months or longer).
4. The 50-day (10-week moving average) is above both the 150-day and
the 200-day moving averages.
5. The current stock price is at least 25 percent above its 52-week low.
(Many of the best selections will be 100 percent, 300 percent, or more above their 52-week low before they emerge from a healthy

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consolidation period and mount a large-scale advance).
6. The current stock price is within at least 25 percent of its 52-week high
(the closer to a new high the better).
7. The relative strength (RS) ranking (as reported in Investor’s Business
Daily) is no less than 70, but preferably in the 90s, which will generally be the case with the better selections. (Note: The RS line should not be in a strong downtrend. I like to see the RS line in an uptrend for at least 6 weeks, preferably 13 weeks or more.)
8. Current price is trading above the 50-day moving average as the stock is coming out of a base.
As the stock transitions from Stage 1 to Stage 2, you should see a meaningful pickup in volume—a sign of institutional support.

VOLATILITY CONTRACTION PATTERN
Once I determine a stock is in a confirmed Stage 2 uptrend—it meets all eight of my Trend Template criteria—I look at the current chart pattern.

The most common characteristic shared by constructive price structures (stocks that are under accumulation) is a contraction of volatility accompanied by specific areas in the base where volume recedes noticeably.

During a VCP, you will generally see a sequence of anywhere from two to six price contractions. This progressive reduction in price volatility, which is always accompanied by a reduction in volume at specific points, signifies that the base has been completed.

As a rule of thumb, each successive contraction is generally contained to about half (plus or minus a reasonable amount) of the previous pullback or contraction. Volatility, measured from high to low, will be greatest when sellers rush to take profits.

Typically, most VCP setups will be formed by two to four contractions, although sometimes there can be as many as five or six. This action will produce a pattern, which also reveals the symmetry of the contractions being formed. I refer to each of these contractions as a “T.”

A stock that is under accumulation will almost always show these characteristics (price tightness with contacting volume).

You can tell supply has stopped coming to market by the significant contraction in trading volume and significantly quieter price action as the right side of the base develops. Demanding that your stock meet these criteria before you buy improves the likelihood that your stock is off the public’s radar,

It’s important to keep in mind that the VCP occurs within the confines of an uptrend. The VCP is going to happen at higher levels, after the stock has already moved up 30, 40, 50 percent or even much more, because the VCP is a continuation pattern as part of a much larger upward move. A stock that is under accumulation will almost always show VCP characteristics. This is what you want to see before you initiate your purchase on the right side of the base, which forms what we call the pivot buy point.

see volume contracting significantly during the tightest section of the consolidation (the pivot point).

How and When to Buy Stocks—Part 2
Most constructive setups correct between 10 percent and 35 percent, some as much as 40 percent. Very deep correction patterns, however, are failure prone.

A stock that has corrected 60 percent or more is off my radar, especially because a decline of that magnitude often signals a serious problem. Under most conditions, stocks that correct more than two and a half or three times the decline of the general market should be avoided.

If the major market indexes ignore an extremely overbought condition after a bear market decline or correction, and your list of leaders expands, this should be viewed as a sign of strength. To determine if the rally is real, up days should be accompanied by increased volume, whereas down days should be on lower overall market volume.

THE 3-C PATTERN
The cup completion cheat, or 3-C, is a continuation pattern. It’s called a “cheat” because at one time I considered it to be an earlier entry than the optimal buy point,

The cheat trade gives you an actionable pivot point to time a stock’s upturn while increasing your odds of success.
qualify, the stock should have already moved up by at least 25 to 100 percent —and in some cases by 200 or 300 percent—during the previous 3 to 36 months of trading. The stock also should be trading above its upwardly trending 200-day moving average

THE “CHEAT” EXPLAINED
Following are the four steps to a stock turning up through the cheat area (see Figures 7-11 through 7-13):

1. Downtrend. The stock will experience an intermediate-term price correction that takes place within the context of a longer-term Stage 2 uptrend.

2. Uptrend. The price will attempt to rally and break its downtrend.

3. Pause. The stock will pause over a number of days or weeks and form a plateau area (the cheat), which should be contained within 5 percent to 10 percent from high point to low point.

4. Breakout. As the stock rallies above the high of the plateau area, you place your buy order.

THE “LOW CHEAT”
The low cheat forms in the lower third of the base. It’s riskier to buy in the lower third of the base than in the middle third (the classic cheat area) or the upper third (from the handle).

The best power plays are stocks that were quiet in Stage 1 and then suddenly explode.
Following the explosive move, the stock price moves sideways in a relatively tight range, not correcting more than 20 percent (some lower- priced stocks can correct as much as 25 percent) over a period of three to six weeks (some can emerge after only 10 or 12 days).

Instead of arbitrarily picking a number, your maximum risk should be no more than 1.25 to 2.5 percent of your equity on any one trade.

I usually will hold 25 to 50 percent of my original position for a larger move in these strong leaders.

Use the math of your results as a tool, and hone your edge by calculating the amount of risk you should be taking based on your own performance.

High-volume reversals
Elevated volume without much price progress—“churning”

If your stock experiences its largest daily and/or weekly price decline since the beginning of a Stage 2 advance, this is almost always an outright sell signal.

Often before a fundamental problem becomes evident, there will be a significant change in price behavior. That change should always be respected even if you don’t see any reason for the sudden shift in sentiment. Earnings may still look good; the story may still be intact. However, in most cases, you’ll be far better off getting out and asking questions later than waiting to learn the reason why, which often doesn’t become apparent until the stock has suffered a large decline.

The 50-day line becomes a trailing stop to protect your profits. This is why we call the rule breakeven or better.

when 12 of 15 days up signaled breakout strength that suggests you should hold for a larger move. It may sound confusing that now I’m telling you essentially the opposite: to sell when you have 70 percent more up days than down days. That’s because now we’re talking about a late-stage exhaustion move versus an early-stage breakout move.

What looks like exhaustion in buying activity in the late stage, giving you rationale to sell a stock, is actually a bullish sign early on and would compel you to keep holding on.

I never buy a falling stock. I always trade directionally. This applies to all time frames, from long-term investing to swing trading and even day trading. Allowing the market to guide you puts you in sync with it, which increases your chances of making a profit and limiting losses.

[Dragon]

Thanks for the Stan and Minerveni quotes/summary. It would be more effective if these quotes/summary can be accompanied with charts.