Using Support Levels as Stops
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.
The position entry shown on the SGRP 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 SGRP position entry is shown below in Chart 1. without the earnings data.
Chart 1. Position Entry and Initial Stop
As shown in the weekly chart above, SGRP has a tendency to trade along a support level for a year or so before moving up to next support level as the stock trends higher. These support levels provide a convenient place for the stop. How far below the support to place the stop is arbitrary. Generally the stop should be fairly close to the support otherwise is starts to defeat the purpose of using the support as a stop. If the stock does close below the support then there is a likelihood that the stock may then trend downwards.
Chart 2. New Support Level
Referring to Chart 2. above, SGRP is starting to form a new support level. At this stage it is probably best if the stop remains at the initial stop under the established support.
Chart 3. Raising the Stop
As Chart 3. above shows, SGRP starts to rally and has left a well formed support level. The stop can be raised and placed underneath the new support level.
An exit signal is given when the stock closes below the stop.
Chart 4. Stop Triggered
Referring to Chart 4. above, SGRP trades down and closes below its stop which gives the signal to exit the position. The stock is sold on the next trading day.
If the position is held this could potentially end up as a big loss should the uptrend turn into a long-term downtrend. Selling a stock at a price that is less than the purchase price can be difficult for some investors. Bear in mind that this is only a small loss and the profitable investments make substantially more money than what is lost on the losing ones.
Stock Analysis for Finance Students and Investors