The gains one can achieve through longer-term investing are much more dependent upon the performance of the market than the gains that can be achieved through short-term trading. Shorter-term investing can increase gains and yield far more consistent returns.
To illustrate the point, let’s assume that a stock rises 15% from $100 and falls 10%. Suppose also that it repeats this scenario three times during a year. Thus, it moves from $100 to $115 and declines to $103.50, rises to $119.025 and declines to 107.1225, then rises to $123.19 and declines to $110.87. A person who bought it at $100 and held it for the year now has a stock priced at $110.87. The investment has gained 10.87%. Therefore, if the initial investment were $10,000 the net return would have been about $1,087-$14 = $1,073 (assuming transactions cost $7 per trade). With the market’s increased volatility, the kind of behavior assumed in this scenario is not rare.
If an individual buys at 100 and sells at 113 ($2 short of the $115 high), buys at 105 (above the $103.50 low) and sells at 117 (short of the next high), then buys at 109 (above the next low) and sells at 120 (below the last high), the gains accumulated would be about 13%, 11.4%, and 10% respectively for a total gain of 34.4%. At a deep discount brokerage, commissions can be as low as $6 or $7 per trade regardless of the amount of money involved or the number of shares traded. Therefore, for our purposes, the brokerage commissions may be considered to be inconsequential. The six trades would cost only about $42. Therefore, if the initial investment were $10,000 the net return would have been about $3,440-$42 = $3,39800. By trading, the individual has more than tripled his net return.
Decisions about when or buy and when to sell are not too difficult if you have a defined set if decision rules fir buying and selling. Buying rules, for example, should be based on the proper formation of “setups” and the occurrence of “trigger events.” Therefore, you need to be able to identify “setups” and “trigger events.” Here is an example. Say that a stock has been moving strongly and that its 50-day moving average is rising rapidly (at a fairly steep angle). When a stock is in a strong bullish mode it will often climb well above its 50-day average. However, stocks have a tendency to return to their mean (in this case, the “mean” is the 50-day moving average). That means the stock will eventually return to its 50-day moving average. When it does, you have the makings of a “setup.” You have a very strong stock that has returned to its rapidly rising 50-day moving average.
Institutional and other investors tend to increase their buying activity when a stock returns to its average. However, the experienced trader does not buy yet because there is no guarantee that the stock will not “break down” and end its rising trend. If the stock begins to rebound off its 50-day moving average, on the other hand, you have proof that the 50-day average is indeed acting as support for the stock. This rebound is your “trigger event,” or buy signal. There are many types of setup, some of which are demonstrated. Expert traders prefer not to buy anything that is not in a “setup” configuration, and even then they look for a “trigger event” as their “go” signal for the trade. The point is that both setups and trigger events are definable and you can learn to recognize them with a little effort.
The same is true of sell points. A stock’s chart pattern will show you where support is. If the stock falls below support, it is time to sell. “Support” is where there is demand for the stock. If that demand cannot keep the price from falling, then there are more shares being unloaded than demand can absorb. If the stock’s pattern does not reveal regions of support, then statistics can be your guide. A volatility-based stop loss will get you out when the stock has a downward surge that is uncharacteristically large for the stock. That is, the stock has declined an improbable amount given its own pattern of volatility.
Once you learn to recognize buy and sell points, your performance need no longer be defined by the annual behavior of your stocks. You are free to sell when it is time to sell. You do not have to wait for the same stock to give you a new buy signal. You can go wherever you find a “setup” and a “trigger event.”
Copyright 2012, by Stock Disciplines, LLC. a.k.a. StockDisciplines.com