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Position Management (Archived)

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

Chart 1. Position Entry

Chart 1 PII

As shown in the weekly chart above, PII is in a strong uptrend and has accelerated its rate of ascent. The stock is vulnerable to a correction but these high momentum stocks can climb to dizzy highs before they correct (the correction may simply be in the form of consolidation rather than a sell off).

The position management needs to be considered. Stocks that are vulnerable to a correction but yet still have the potential for significant gains needs a trailing stop strategy that can detect when the uptrend might have ended but yet still allows the stock to briefly consolidate its gains before the next rally. A good strategy to utilize here 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 PII

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 PII

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, the savvy investor can use this signal to place a fixed stock just below the current close at say 123.00 and give the stock a chance to rally from its current congestion. Should PII trade down and close 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 PII

Referring to Chart 4. above, the SAR indicator has plotted a dot below the stock price. This signals that the uptrend has resumed after the congestion. The uptrend is confirmed by the stock chart which shows that PII has rallied to new highs. 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 PII

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.

Since PII is in a strong long-term uptrend it would worthwhile giving PII the chance to climb higher. Using the SAR signal to place a fixed stop at say 140.00 would only risk a small amount. If PII does trigger the fixed stop the investor still makes a profit (its just a bit less). The potential reward could be significant and easily outweighs the small amount risked of the open profit.

Chart 6. PII triggers its Fixed Stop

Chart 6 PII

As Chart 6. above shows, PII 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 PII position is closed out and netted a profit of over 10% over a 15-month period.

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