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Position Management (Archived)

Position Management with Strong Rallies

picture trailing stop

Value investing is a popular strategy with investors. This bargain hunting strategy can provide good returns over the long-term. The returns can be enhanced with stocks that continue to trend 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 AEL chart from the October 2014 Value Stocks article was based purely on fundamental considerations with no regard to the position's entry or its subsequent management. The AEL position entry is shown below in Chart 1. without the earnings data.

Chart 1. Position Entry

Chart 1 AEL

As shown in the weekly chart above, AEL is a stock that is rallying strongly and has nearly doubled in price within the last year.

Strongly rallying stocks are at risk of a trend reversal and a position in such a stock can be easily managed with a technique referred to as the 2nd Low Trailing Stop. This trailing stop is a trading technique which is ideally applied to a monthly bar chart when used by investors who have a longer term view.

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

Chart 2 AEL

Referring to the monthly bar chart above, the last monthly bar with the position entry has not yet completed as the entry is on 25-Sep 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

Chart 3 AEL

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.

Trading below the Stop

An exit signal is given when the stock closes below the stop.

Chart 4. Trading below the Stop

Chart 4 AEL

Referring to Chart 4. above, AEL trades below the stop during the month but closes the month above the stop. An exit is only signaled when the stock closes below the stop.

No exit signal is given since AEL closed above the stop.

Chart 5. Multiple Bars with the Same Lows

Chart 5 AEL

Referring to Chart 5. above, AEL has three 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 5. 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.

Chart 6. The Order of the Bars

Chart 6 AEL

Chart 6. above shows that the bars HL, 1 and 2 can be jumbled up - they do not need to be sequentially from right to left. What's important is locating the highest low (HL), then the first highest low below HL and then the second highest low below HL - the order they occur in is irrelevant.

Chart 7. Multiple Bars with the Same Lows

Chart 7 AEL

Chart 7. above shows another example where there are three bars with similar lows for bar 1 and either bar can be used for bar 1. The bar 2 in this situation is at the previous rally high bar - this is where the 2nd low below HL is found. The HL, 1 and 2 bars do not need to be adjacent to each other.

Chart 8. Exit position

Chart 8 AEL

The trailing stop is raised and the stock closes below the stop as shown above in Chart 8. The position should be exited the following trading day.

Buying high in a rally netted a capital gain of only 15% over a 23-month period.

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