Trailing Stops with Monthly Bars
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 ALXN chart from the August 2014 Growth Stocks article was based purely on fundamental considerations with no regard to the position's entry or its subsequent management. The ALXN position entry is shown below in Chart 1. without the earnings data.
Chart 1. Position Entry
As shown in the weekly chart above, ALXN has traded up to a new high and then pulls back and trades along the support level before starting to rally again. This is where the hypothetical position was taken with the entry criteria being based solely on fundamental analysis. From a technical analysis point of view this is a high entry and the ideal placement for the initial stop would be below the support level. However another technique can be used to manage this position which is referred to as the 2nd Low Trailing Stop which is ideally applied to a monthly bar chart.
Monthly Bar Chart with 2nd Low Stop
The 2nd Low Stop is a trailing stop method that is well suited to investing when using monthly bars. The technique is quite simple and requires the investor to locate the next two bars with lows that are lower than the bar with the highest low.
Chart 2. Monthly Bar Chart with 2nd Low Stop
Referring to the monthly bar chart above, the last monthly bar with the position entry has not yet completed as the entry is on 18-Jul therefore this bar is ignored.
The initial stop is determined by:
- Locating the bar before the entry bar with the highest low. This bar is marked with HL (Highest low).
- Now locate the bar with the next low below the HL bar's low. This bar is marked with 1 (the 1st low below HL).
- Now locate the bar with the next low below the 1 bar's low. This bar is marked with 2 (the 2nd low below HL).
- The initial stop is placed just below the low of the bar marked 2.
Chart 3. Raise 2nd Low Trailing Stop
The 2nd Low stop is checked for every month. If the new stop is higher than the current stop then the new stop level is used. If the new stop is lower than the current stop then the current stop continues to be used.
The closing prices used are monthly closes since the charts are monthly bar charts. This means the closing price for the last trading day of the month.
Chart 4. Placing the Trailing Stop
Referring to Chart 4. above, the trailing stop is higher up than the third monthly bar from the right. Thus the third monthly bar actually penetrates below the stop. What is important here is the correct identification of the HL, 1 and 2 bars. These bars will probably not be sequential from right to left.
Chart 5. Raise 2nd Low Trailing Stop
Chart 5. above shows another common sequence of the HL, 1 and 2 bar locations.
Chart 6. Multiple Bars with the Same Lows
Referring to Chart 6. above, ALXN has five bars with similar lows. In a situation where there are several lows its best to group all those lows together and label them the same (labeled 1 in Chart 6. above) - otherwise the stop may end up way to close to the HL (highest low) and thereby not allowing enough room for the stock to move and thus prematurely stopping the stock out.
The ALXN position remains open as it has not triggered its trailing stop. The unrealized capital gain is around 70% over a 15-month period.
Stock Analysis for Finance Students and Investors