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Position Management (Archived)

Managing False Exits with the SAR

picture trailing stop

Dividend paying stocks are popular with investors seeking an income stream. These stocks can also provide solid capital gains while they continue 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.

Position Entry

The position entry shown on the CVS chart from the September 2014 Dividend Stocks article was based purely on fundamental considerations with no regard to the position's entry or its subsequent management. The CVS position entry is shown below in Chart 1. without the earnings data.

Chart 1. Position Entry

Chart 1 CVS

As shown in the weekly chart above, CVS is in a strong uptrend and is pulling back from a new high. Ideally one would wait for the pullback to complete but the entry was based solely on fundamentals without any technical considerations.

There are several position management strategies that could be used here. A good strategy with strongly trending stocks is a trend following indicator known as the SAR indicator (which stands for Stop And Reverse). This indicator tracks the trend and alerts the investor when the trend might be reversing.

SAR Indicator

The SAR indicator needs its parameters altered to make it suitable for the longer term trends. The standard parameter values are (0.02,0.2) which is designed for short-term trading with daily charts - these do not work with investing time frames. Suitable parameter values for investing with trending stocks are (0.05,0.05) which are applied to a weekly chart.

Chart 1. is shown again in Chart 2. below with the SAR indicator applied.

Chart 2. SAR Indicator

Chart 2 CVS

The SAR Indicator plots a dot below the stock price while the stock is trending upwards and plots a dot above the stock price while the stock is in a downtrend.

SAR Indicator Exit Signal

An exit signal is given when the SAR indicator plots the dot above the stock price.

Chart 3. SAR indicator gives Exit Signal

Chart 3 CVS

The SAR indicator plots a dot above the stock price - this is an exit signal alerting the investor that the trend may be reversing. The investor could simply sell their stock on the next trading day.

However, closer examination of the chart reveals that CVS has pulled back and closed right at the potential support level. Technical analysis tells us that the stock may well bounce up from the support and that a stop should be placed below the support. This is in conflict with the SAR indicator which has given a signal to exit now.

Successful active investing involves analyzing the situation and coming up with a logical plan. While the investor could sell the stock there is a good chance that the stock may rally from here. The logical thing to do here is to place a fixed stop below the support and give the stock a chance to rally. Should CVS continue trading down and closes below the fixed stop then the stock should be sold. Sometimes it's worthwhile risking a few more dollars when the potential to make significantly more money is there.

The Uptrend Continues

A continuation of the uptrend is signaled when the SAR indicator plots the dot below the stock price.

Chart 4. The Uptrend Continues

Chart 4 CVS

Referring to Chart 4. above, the SAR indicator has plotted a dot below the stock price. This signals that the uptrend might be resuming after the pullback. The fixed stop is now removed and the uptrend is tracked with the SAR indicator for the next exit signal.

Chart 5. SAR Indicator Tracks the Uptrend

Chart 5 CVS

Referring to Chart 5. above, the SAR indicator continues to track the uptrend by plotting a dot below the stock price.

The position in CVS remains open and the unrealized gain is around 100% over a 17-month period.

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