Position Re-Entry with Uptrending Stocks
Investing in Growth stocks is a popular strategy with investors. The strategy provides strong returns while the stock continues trending upwards, however these uptrends can reverse with little warning. The position management strategies used by stock traders with their short-term trades can be easily applied to the long-term trends found with investing.
Position management works best with trending stocks that are expected to continue with their long-term uptrend. The position management strategies generally give poor results with stocks that are not trending.
Using position management strategies changes investing from a passive process into an active process! This may not suit some investors especially those who do not have the time or inclination to actively manage their investments. There is no requirement for investors to use any of the position management strategies. Some investors may simply be interested in the process involved and may consider employing these strategies when market conditions become difficult.
The position management strategies are analyzed using stocks from the Fundamental Investing series of articles. These articles consist of a selection of stocks analyzed for their investment potential and a hypothetical position is taken.
The position entry shown on the WSM chart from the June 2014 Growth Stocks article was based purely on fundamental considerations with no regard to the position's entry or its subsequent management. The WSM position entry is shown below in Chart 1. without the earnings data.
Chart 1. Position Entry and Initial Stop
As shown in the weekly chart above, WSM had formed a Pennant with a Flagpole pattern prior to the hypothetical stock purchase. From a technical analysis point of view, the entry timing was late and probably should not be taken as WSM may have already reached its target move from the Pennant breakout. This means that WSM may be ready for a pullback and this needs to be taken into account with placing the initial stop (The Initial stop is the first stop-loss price level placed).
For the Pennant, a good place to put the initial stop is below the lower boundary but this is a long way down from the entry price. A more practical level to use is based on a percentage that the stock is expected to pullback by. Allowing 10% is a fairly good rule of thumb and will likely give the potential pullback enough room. If the stop is too close then the stock will likely be stopped out before it has a chance to advance.
As a general rule, investors need wider stops than traders since investors are looking for the big moves.
Trailing Stop and Position exit
Once WSM starts to rally the stop should be raised (the stop is now referred to as a Trailing Stop). There are dozens of trailing stop techniques used by stock traders but not all are suitable for investing.
The simplest trailing stop for investors to use is the percentage method which is the method that was used to place the initial stop.
With the percentage trailing method the investor raises the stop level whenever the stock closes higher than the previous highest close. The stop level is placed at a fixed percentage below the highest close.
Chart 2. Triggering the 10% Trailing Stop
Since the initial stop used 10% the trailing stop will also use 10% below the highest close. The closing price is the weekly close since the charts are weekly line charts. This means the closing price for the last trading day of the week (usually Friday).
Referring to Chart 2. above the trailing stop was raised to 10% below the highest close. WSM is pulling back from the highest close and has closed below the trailing stop. The stock is sold on the next trading day.
Quite often it is worthwhile taking another position in the stock that the investor was just recently stopped out from. One of the quirks with position management is that the investor may be stopped out of investments that actually continued with its long-term uptrend.
Chart 3. Position Re-entry
After the position in WSM was stopped out, the stock bounced up from the 52wk MA (moving average). In technical analysis, rebounds from dominate moving averages provide a higher than usual probability that the stock will continue in the original trend direction. A hypothetical position can be taken. This time the initial stop can be conveniently placed below the low of the pullback.
The percentage trailing stop method will be used to manage the new position.
Chart 4. Raise 10% Trailing Stop
Referring to Chart 4. above, the trailing stop is activated once WSM closes above the Rally high marked on the chart. The trailing stop is placed at 10% below the new highest close.
Chart 5. Raise 10% Trailing Stop
Referring to Chart 5. above, the trailing stop is raised to 10% below the highest close which is marked as Rally high on the chart..
Chart 6. Position stopped out
Referring to Chart 6. above, the trailing stop is raised to 10% below the highest close which is marked as Rally high on the chart. WSM then pulls back and closes below the trailing stop which gives the signal to exit the position. The stock is sold on the next trading day. The re-entered position gained around 35% over a 10-month period.
Stock Analysis for Finance Students and Investors