Tracking Rallies 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 CBPO chart from the December 2014 Growth Stocks article was based purely on fundamental considerations with no regard to the position's entry or its subsequent management. The CBPO position entry is shown below in Chart 1. without the earnings data.
Chart 1. Position Entry
As shown in the weekly chart above, CBPO is a stock that has risen significantly over the last five years.
Stocks that make large gains in a short amount of time are at risk of a trend reversal. A position in such a stock needs to be managed. An appropriate position management strategy is to switch the weekly line chart to a monthly bar chart and use the 2nd Low Trailing Stop technique.
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 - 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 20-Nov 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.
Multiple Bars with the Same Lows
Quite often the stock chart will display several bars which have similar lows.
As Chart 2. above shows, there are two bars the have essentially the same lows for the 1st low below HL and there are two bars for the 2nd low below HL - which one does the investor use?
Where there are multiple bars with similar lows then the best thing to do is to group all those bars together and mark them the same. In the above chart two bars are marked as 1 and treated the same and there are another two bars marked as 2.
Now the investor can place the stop below bar 2 and it does not matter which bar 2 is used as they are nearly the same level.
If the investor has trouble trying to decide which bar 2 to use then as general rule when a position is first opened it would probably be better to use the bar 2 with the lower low to give the stock some more room to move. When the stock has rallied it would probably be better to use the bar 2 with the higher low to tighten up the stop slightly.
Chart 3. below shows another example of multiple bars with similar lows.
Chart 3. Monthly Bar Chart - 2nd Low Stop
As Chart 3. above shows, there are five bars the have essentially the same lows for HL. These five bars can be grouped together and all marked as HL.
There are two bars with similar lows for the 1st low below HL. These two bars are both marked 1. Also there are two bars with similar lows for the 2nd low below HL. These two bars are both marked 2.
The 1 and 2 bars are the same bars as in Chart 2. which placed the initial stop and hence the stop remains unchanged.
Raising the Stop
The stop is raised when the 2nd low below HL gives a higher low.
Chart 4. Raising the Stop
Referring to Chart 4. above, the 2nd low below HL is higher therefore the stop can be raised and place just beneath the bar marked 2. Note that bar 1 has two bars with similar lows.
Chart 5. Raising the Stop
Referring to Chart 5. above, the 2nd low below HL is higher therefore the stop can be raised and place just beneath the bar marked 2.
Chart 6. Raising the Stop
Referring to Chart 6. above, the 2nd low below HL is higher therefore the stop can be raised and place just beneath the bar marked 2.
Chart 7. Closes above the Stop
The stock trades below the stop but closes the month above the trailing stop as shown in Chart 7. above.
Since the stop has not triggered the CBPO position remains open. The unrealized capital gain is an impressive 350% over a 25-month period. These large capital gains is what really boosts the investor's returns.
Stock Analysis for Finance Students and Investors