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Position Management (Archived)

Trend Strength Indicators

picture trailing stop

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.

Position Entry

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

Chart 1. Position Entry

Chart 1 LOPE

As shown in the weekly chart above, LOPE is has formed a strong uptrend having rallied to a new 5-year high. Essentially there are two methods to manage a position - the first is to used stops with a fixed price and the second is to use an indicator that will alert the investor to when the trend might be reversing.

There are trend following indicators that work well with strongly trending stocks. These indicators allow the investor to capture a sizable portion of the trend. The investor can use several indicators simultaneously and is not restricted to using only one indicator at a time.

Two indicators that do a good job of identifying when a trend is weakening are the ADX indicator and the 20 week Exponential Moving Average (20EMA). These two indicators can be used to signal that it might be best to exit the position as there is a risk that the trend will reverse.

Tracking the Trend with Indicators

Chart 1. is shown again in Chart 2. below with the ADX indicator applied to a sub-chart attached to the bottom of the chart (The sub-chart is referred to as a Chart Pane). Also the 20EMA is plotted on the chart along with the 52 week moving average.

Chart 2. Tracking the Trend with Indicators

Chart 2 lope

Referring to Chart 2. above, there's actually three indicators tracking the trend.

The 52 week Moving Average (52MA) tracks the long-term trend. An uptrend is indicated when the 52MA slopes uptrend. A strong uptrend is indicated when the stock's price line rises up above the 52MA without penetrating the 52MA.

The 20EMA also tracks the uptrend and indicates a strong uptrend when the stock's price line rises above the 20EMA without penetrating the 20EMA. The 20EMA serves basically the same purpose as the 52MA for a strong uptrend but the 20EMA is fast acting and gives a potential reversal signal a lot earlier than the 52MA. A potential reversal signal is given when the stock price closes below the 20EMA. A potential reversal signal means that the trend is at risk of reversing rather than it has reversed - hence it's an early signal which is best used to indicate that the trend is vulnerable to a reversal.

The ADX indicator plotted in the chart pane measures the trends strength. There are three lines with this indicator:

  • The ADX indicator (black line) gives a strength reading (values above 30 indicate a strong trend)
  • The other two lines are the directional indicators, +DI (green line) and -DI (red line). An uptrend occurs when the +DI is above the -DI. A weakening of the trend is indicated when the +DI drops below the -DI.

20EMA Exit Signal

A possible trend reversal is signaled when the stock closes below the 20EMA.

Chart 3. 20EMA Exit Signal

Chart 3 LOPE

Referring to Chart 3. above, the stock closes below the 20EMA which means that the stock is vulnerable to a trend reversal. The ADX indicator has not given a reversal signal but is close to it.

The cautious investor could exit here. The more adventures investor might prefer to wait for the ADX to also signal an exit.

ADX Exit Signal

The ADX signals an exit when the +DI drops below the -DI.

Chart 4. ADX Exit Signal

Chart 4 LOPE

Referring to Chart 4. above, the ADX gives an exit signal as the +DI has now dropped below the -DI. Also the trend strength has weakened as the ADX indicator (blank line) is now below 30. Also LOPE is forming a descending triangle which technical analysis considers to be bearish. Therefore now might be a good time to exit the position and sell the stock on the next trading day. The investment netted a profit of around 15% over a 9-month period.

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