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Position Management (Archived)

Managing Positions with the SAR

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

Chart 1. Position Entry

Chart 1 BIDU

As shown in the weekly chart above, BIDU 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 BIDU

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 BIDU

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 BIDU has pulled back and closed right at the potential support level at 150.00. 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 BIDU 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 BIDU

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.

SAR gives another Exit Signal

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

Chart 5. SAR gives another Exit Signal

Chart 5 BIDU

Referring to Chart 5. above, the SAR indicator gives another exit signal as the dot is plotted above the stock price. The investor could act on this signal and sell the stock the next day. However the SAR indicator does tend to give some false signals.

An intelligent investor would reason that BIDU is pulling back in a strong uptrend and there is quite a good chance that the stock will rally. A savvy investor would risk some of the open profit in order to make even more money. A fixed stop could be placed below the current price and the stock sold if it closed below this stop. By using a fixed stop and leaving the position open the investor gives BIDU a chance to rally. If BIDU does trip its fixed stop then the investor only hands back a small portion of their sizable profits made. This was a tactic the famed speculative investor Jesse Livermore made good use off.

Chart 6. BIDU triggers its Fixed Stop

Chart 6 BIDU

As Chart 6. above shows, BIDU trades down and closes below its fixed stop. In this case using the fixed stop netted a lower return, but investing is all about risking some money in order to make a lot more money.

The BIDU position is closed out and netted a profit of over 30% over a 16-month period.

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