I normally wait a while between newsletters but a recent event prompted me to write a follow up on the last email I sent you. The recent event was the dramatic fall in the stock Suncorp.
SUN is a stock that many brokers have been recommending to buy, based on fundamental research. However it is not a stock that I would have bought following a trend trading method, like the one I teach.
In the last email I was talking about having a pre determined exit for your stocks. Also you may have noticed the quote by the highly regarded trader William O’Neil that went…
"What seems too high and risky to the majority generally goes higher and what seems low and cheap generally goes lower."
Trading and investing is about probability, statistics continually show it makes sense to buy stocks that are going up, not down. So what simple method should we use to determine if something is going up? I use charts of a 2 year time frame, on a weekly scale. The weekly scale is preferred over a daily scale to minimize the distracting daily volatility on the chart.
A simple method is to look at the stock chart and see if the price is rising from the left hand bottom of the chart to the right hand corner of the chart, that’s an uptrend. If the stock is not doing that then its either in a downtrend or a sideways move, so it does not fit Williams (or my) criteria of “going higher”. I will show you in pictures what William means by “going higher”.
AHD is in an uptrend. the stock is moving from the bottom left hand corner of the graph to the top right hand corner.
COH is in an uptrend. It has made a new high recently after some sideways movement. It too is moving in the preferred direction, up.
SUN has not been in an uptrend for over 12 months. If following a trend trading method it would never of been a recent buy. It has now made a fresh one year low.
I would like to make clear I am not criticising fundamental research of a company. I am not saying charting is "better" or economic research of a company is unnecessary, or that analysts are incompetent. Fundamental analysis has an important place. The fact remains that the rhetoric about SUN was not being supported by the chart price action. I like to use all the tools at my disposal, if I have two tools like fundamental research AND technical analysis (charting) to assist me then I will use them in a complimentary fashion. So should you if you want to enhance your returns.
Statistical proof about uptrends:
For those that wont take my word for it, (or William ONiels)here are some statistics to make you think a little.
In the last email I discussed a method of investing that bought a fresh one year high of a stock and as an exit was sold if the price fell by 25%.
Running a test of 360 trades over the last 4 years on ASX 300 the results of that method were a 53% win rate, an average profit of 54% and an average loss of 16% .
So that’s a 3.4 to 1 reward to risk ratio with a 53% win rate…..if you buy uptrends.
If you persist in buying stocks that are going down (like SUN) and stocks that are making fresh one year lows here are the numbers.
Win rate of just 34% (down from 53)
Average profit of 43% (down from 54)
Average loss of 18% (up from 16…..in fact that small number of difference is a good example of how having stop losses even in a poor method saves you money)
So that’s a 2.4 to 1 reward to risk ratio with just a 43% win rate …..if you buy downtrends
I could go on with more numbers and examples, and the mathematically inclined can crunch the above numbers to their hearts content. The bottom line just keeps giving the same resounding message, be very careful buying a stock that is going down, the odds are against you and you just don’t ever know when that downtrend will stop. Also, the first method far outperforms the second method, in fact a portfolio makes twice as much money over the long term.
So next time you see, read or hear about a stock to buy, just keep those numbers above in mind and check the direction of the share price….is it going up or down? The stock that is going down has a lot less chance of making you a return than the one going up.
Buying stocks that are rising gives you a better chance of achieving your goals, which I would presume is to increase the chance of profits and reduce the chance of losses. Using the uptrend method rather than the downtrend method will make you a lot more money and more importantly save you a lot of stress and emotional pain.
Peter. Ph: 0403821523
A man should look for what is, and not for what he thinks should be.