Chapter 20
IN THIS CHAPTER
Quickly finding strong areas of the market
Holding your winners (while keeping your cool)
Selling winners and losers
You will never hear a CEO announce to shareholders that it’s time to sell the company’s stock. That role is specifically left to investors and traders. Deciding when to buy a stock and when to sell a stock is your decision. Nobody in the markets thinks it is easy to actively work the markets. It takes time, commitment, and patience. Buying the stock of great companies with beaten-down prices takes a lot of courage. Buying the stock of great companies hitting new highs takes just as much courage. In this chapter, we take a look at how to use charts to help improve your decision making on buying, holding, and selling stocks.
Focusing on strong stocks is one of the most important themes of the market. Usually those strong stocks are part of a strong sector. We have multiple methods of finding strong stocks and sectors with technical analysis. Three of these are covered in depth in Chapter 12 on relative strength:
All three of these tools are available if you’re a member of StockCharts.com
. (On the home page, you see a green button that says “Free 1-Month Trial.”) From the Members page, you want to focus your tasks on finding strong areas of the market. Understanding how to identify strong sectors and industries quickly is very important; the following sections can help. Click along with the following instructions to develop your skill level using the site.
Chapter 12 has an infographic explaining the stock market and showing you the sectors, industries within each sector, and stocks within each industry. You will need to drill down into these sectors very quickly. Combining the various StockCharts.com
relative strength tools helps you see strength in the market based on your investment timeline. All of these tools are accessed from the Pro Control Center on the Members Page.
In the Pro Control Center (see Figure 20-1), scroll down to Reports & Analysis Tools. Notice the top five buttons in this Reports & Analysis area are all designed to help you see what is going on in relative strength and popularity. Working with the Sector Summary and the Industry Summary, you can find the strong sectors and strong industry groups quickly. Start with the Sector Summary button and use this link to drill down into the industries and stocks.
Click “Sector Summary (Drill down into the major market sectors)” to open a screen sorting Sector ETFs. (See Figure 20-2.)
On this Sector screen, adjust the sort order by clicking on the column headers. Click on SCTR to see the top overall sectors first. On the top left, you can click on different time periods. The default setting is Intraday, but we have adjusted it to show the change over three months. Other time frames are one week, one month, six months, and a year. Three months is a sweet spot. This period is long enough that you can see a meaningful trend start but not too short.
Click on any sector name and it will take you to the industry lists within that sector. In Figure 20-3, technology is shown. Because you can’t actually buy an industry group, there is no SCTR for each one. Change the time period on the top left to see the industry performance over different time intervals. The screenshot in Figure 20-3 has one month selected from the drop-down menu. For industries, one-month changes can identify new trends early. You can use three months as well for swing trading. Longer periods tend to be too long for practical use in identifying new trends. Shorter periods like one week can just be normal market oscillations.
To continue drilling down to the stock level, click on an industry name. Figure 20-4 shows you the stocks in the software industry. Click on the SCTR column to bring the strongest stocks to the top, with an SCTR in the 90s at the top of the list.
The column to the right of the SCTR shows the SCTR peer group. Click on the U column to sort on market cap size. The stocks with no SCTR may be at the top, but scroll down to the market cap–size stocks you like to work with (for example, perhaps you are only a large-cap investor). Then alter the time using the drop-down menu in the top left corner to one week, one month, or three months. When stocks start to show up on these lists, something is going on that is making investors show interest in them. Stocks that are performing well usually have a reason. Investigate the chart pattern to see whether a stock is changing trend from down to up for a possible entry. Note: Not all stocks have SCTRs due to a small market cap or a low stock price, or they may be foreign small- or mid-cap stocks.
With this quick technique, combining the Sector/Industry/Stock drill-down with the SCTRs and the % Change bars, you can find strong stocks fast.
Under the Pro Control Center, scroll down to Reports & Analysis Tools. The Industry Summary button brings up all the industries on one page and allows you to change the look-back period in the center at the top of the page. Change from intraday to one-week, one-month, and three-months to find emerging areas of strength.
When you know which industries you’re interested in, you can use the Sector Summary to drill down and find stocks you like based on your chart settings.
You may have actually bought a strong stock using some of the tools on StockCharts.com
, or you may have used this technique to start watching how some stocks perform. Technical trading gets emotional because you see the price moves relative to history and you want to hold your gains. When the markets have a bad day, it makes you want to sell every stock going down to preserve your profits. That’s not a great idea. Instead, use the guidance in the following sections to help you decide how long to hold a stock.
Some stocks, such as biotech stocks, can have sudden shocks that wipe out profits and become huge losers very quickly. They also go up very fast. It’s a double-edged sword. This volatility is helpful if you are in strong stocks across multiple sectors, but you never want a significant portion of your portfolio in any one stock.
You may want fast-moving stocks, but you want to sell with profits. Slow-moving stocks have trouble outperforming the market averages, so typically you want some faster movement. The relative strength indicator will be rising if the stock is rising faster than the S&P 500. The SCTR (see Chapter 12) should be well above 75 for identifying stocks going up faster.
For information on moving averages and horizontal support and resistance, go to Chapter 10.
Unfortunately, there is no magic percentage gain for selling because different market conditions lead to faster or slower markets. Identifying the strength of the stock can help with the management of the trade. Determining when to lock in gains is also a somewhat emotional decision to make; some people are risk takers and some are not. Risk takers may ride a gain for a longer period of time than non–risk takers.
Many investors look to lock in profits above a 25 percent gain by selling the shares as the momentum rolls over (indicated by the moving average convergence divergence indicator, or MACD; see Chapter 11), or they use options to protect their profits and continue to hold the stock. This gives the investor some time to see whether the stock can regain the momentum.
Stocks that have moved up rapidly (25 percent within a couple of months) have some terrific momentum. Usually they will have more upside available, but the stock price may need to wobble sideways and consolidate the gains. If the whole industry is running fast, that adds to the likelihood that there are more gains to come.
Figure 20-5 shows Amazon (AMZN), which is one of the world’s juggernaut companies. By dominating one particular space so well, Amazon has been crushing everyone in its path. But Amazon investors have ridden some massive swings.
For example, in 2014 the Federal Reserve had lots of stimulus going on to help the economy heal from the financial crisis. The market was roaring higher until the oil business struggled in late 2014. But Amazon was a dog all year, after years of running higher. The chart in Figure 20-5 shows a few big things:
Depending on your investment style, what works for you? If you’re a very short-term trader and hold stocks for only a few days, you use much shorter time periods on your charts. If you want to hold a stock for weeks and even months, you aren’t going to sell just because the stock made new four-day lows, whereas a short-term trader would have already exited a trade.
Refer to the Amazon stock shown in Figure 20-5. Traders out below the 10-week moving average and back in when the stock rises above had a choppy year after a solid 2013. The same applied to the 20-week moving average traders. The traders who sell when the stock moves below the 40-week moving average spent most of 2014 ignoring the stock. When they did get in (July and November), the stock immediately went back down. Ouch. While the example highlights whipsaws (failed breakouts) above the 40-week moving average, there were only five weeks of whipsaws in 2.5 years.
One big consideration is taxable gains. If you have to pay some tax to the government every time you sell, you may choose to hold through larger downtrends on big juggernaut stocks. The issue comes when the stock continues down for three years and you have given up all your gains. (Microsoft did exactly that in 1999 and lost 70 percent from the highs.)
There is no sign at the top saying “Exit now.” If there were one, everyone would sell and there would be no buyers. The January 2014 plummet for Amazon in Figure 20-5 was a sell sign near a top. But as a shareholding investor, you have to decide what to do based on your time frame. Stocks don’t usually recover quickly when they drop past ten weeks of previous price action.
Selling stocks for a loss is part of technical trading. Obviously, the preference is to sell stocks when they’re winners. The worst trades are the ones that immediately reverse when you enter into them and take you to a loss position. Taking small losses rather than large losses is akin to paper cuts versus amputations. If you can keep that discipline to keep losses very small, you will make a lot of money in the markets. Some very profitable traders lose money on 40 to 60 percent of their trades.
Some settings on StockCharts.com
can help with exiting a stock based on technical indicators, as you find out in the following sections.
Chandelier exits can help indecisive investors. Chandelier exits are placed as a line on the chart that is a maximum retracement off the most recent high. As the price moves up, so does the line. Eventually the stock drops in price and kicks you out.
Put the overlay on the chart by selecting Chandelier Exits from the Overlays drop-down menu and click Update (flip to Chapter 3 for an introduction to overlay settings). Check to see whether the price goes below the line too often. If so, increase the range from 3.0 to 4.0 until the line fits the stock better. Two chandelier exit lines are shown on Figure 20-6 on the panel with the price bars.
The Cabot Oil and Gas (COG) weekly chart is shown in Figure 20-6. The chandelier exit set at 3.0 would have kicked you out in October 2016, but the setting of 4.0 would have been okay. In that example, changing 3.0 to 4.0, which is four times the average range for a week rather than three times the average range, works better as a setting. However, for most of the downside moves in 2014 and 2015, getting out earlier would have been better.
Parabolic stop and reverse, commonly called parabolic SAR, moves the stop closer to the price as the advance continues. Eventually, the stop is very close to the price and kicks a sell signal. Parabolic SAR is found in the Overlays area. Figure 20-7 shows the default settings for the parabolic SAR. The parabolic SAR dot will move up above the highest price recently recorded and move the system to a sell signal. This system works well on strong trending stocks, but is terrible during sideways consolidations.
For Cabot Oil and Gas, the parabolic SAR was on a sell signal for most of 2015. In 2016, it switched to a very profitable buy signal. However, from June 2016 through most of 2017, the sideways chop was an awful solution, with every trade losing money as a buy-high, sell-low trade. In a full parabolic SAR system, you would short the stock when the system reversed, until the price of the stop was hit to the upside, telling you to go long on the stock. In this example, shorting the stock would have only doubled your losses in the sideways chop. You don’t have to short the stock; you can just sell the shares you have and wait for another buy signal to trigger on the parabolic SAR or use other indicators you like. For this reason, use the parabolic SAR on strong trending stocks only.