Wednesday, December 4, 2013

Long-term trading rules: Two changes

I've made two changes to my long-term trading rules, in light of the outcome of my trade in AT&T Inc. (T). (See the update at the top of my post, "November long-term trade: T").

After I opened the position in early November, T executed a perfect head fake, leaving me with a loss.

As any trader knows, head fakes happen. They're part of the game board and must be accommodated.

And losses are part of game. Any trader who agonizes over losses needs to find another sandbox, such as the lottery. (Although, the lottery is a perfectly good speculation. See my essay, "Trading the lottery".)

My essays on long-term trading, "The I Hate Stocks Trading Plan" and "Long-term trading rules", recognized the possibility of losses.

So when losses occur, there is no agony at my trading desk. I do, however, take a look at the losing trade to consider rule changes that might lead to better outcomes.

In the case of T, the bull signal breakout came on a chart that had clearly been rising in the past month. I opened a bull positoin on Nov. 1, the first day of the month, after T closed the month above its 12-month moving average. The next day, the price dropped, although it wasn't clear on the chart until Nov. 5 that wave A of a downside correction had begun.
T 180 days 4-hour bars

So bottom line, I couldn't have avoided entering the position under the rules I had set myself, but I could have gotten out much earlier, with far less loss, had I included the trend on the chart as an exit signal.

Or perhaps I could have avoided the trade. A quick-and-dirty Elliott wave analysis shows clearly that T was in the fifth and final wave of its uptrend, which was, under Elliott doctrine, nearing its end.

Also, had I been paying attention to the six-month chart, I would have clearly seen that T is in a downtrend. To open a "long-term" bull position on a chart like this without something more than a moving-average breakout to buttress the play is sheer wishful thinking.

To accommodate that line of thinking, I've made changes to the Entry and Exit sections of my long-term trading rules, which can be read here. The changes are in bold face type.

One more point. I wrote he I Hate Stock Trading Plan as an easy method for people who lack the time or interest in managing their investments more than once a month, and who have no experience in the intricacies of advanced chart analysis. By adding chart analysis to my long-term trading plan, I'm pulling the switch part of a bait and switch.

To redeem myself after such a sly maneuver, I'll outline a quicker method of chart analysis that requires only a chart on the screen and a piece of paper. It's called the I Hate Charts Trend Finder.

Despite the tongue-in-cheek name, this method is intended seriously. Everyone can tell at a glance whether a chart is fundamentally bullish or bearish, if only they find a way to step out of the weeds and simply look. The human brain does a great job of pattern recognition.

Here are the steps in finding the trend:
  • Pull up a one-year year daily chart.
  • Locate the high point on the chart.
  • Locate the current price.
  • Align the edge of the piece of paper from the high point to the current price.
  • If the edge of the paper points up, the stock is in an uptrend.
  • If the edge points down, the stock is in a downtrend.
  • If the stock is in a downtrend, then don't open a bull position.
  • If the stock is in an uptrend, then don't open a bear position.
There's nothing mandatory about the one-year chart. Six months will work just as well. Or even a month. Charts contain trends within trends. The length of chart the trader analyzes depends upon his or her time horizon for the trade.

That's it. For my own trading, I'll continue to use Elliott wave analysis to parse the charts, but I make no claim that Elliott is the sole, or even the best, method for determining the trend.


Elliott wave analysis tracks patterns in price movements. The principal practitioner of Elliott wave analysis is Robert Prechter at Elliott Wave International. His book, Elliott Wave Principle, is a must-read for people interested in this form of analysis, as is his most recent publication, Visual Guide to Elliott Wave Trading

Several web sites summarize Elliott wave theory, among them, Investopedia, StockCharts and Wikipedia.

See my post "Chart Analysis: Nomenclature" for an explanation of my method for labeling waves on the chart.

Tim Bovee, Private Trader tracks the analysis and trades of a private trader for his own accounts. Nothing in this blog constitutes a recommendation to buy or sell stocks, options or any other financial instrument. The only purpose of this blog is to provide education and entertainment.
No trader is ever 100 percent successful in his or her trades. Trading in the stock and option markets is risky and uncertain. Each trader must make trading decision decisions for his or her own account, and take responsibility for the consequences.

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