Based on the Stock Charts for MO, MPEL, STX, shown below

The charts below show three stocks in which I hold a long position and the chart patterns, as I read them, tempt me to make a trade at this point if nothing changes after the first hour of trading when the market opens on Tuesday after the Memorial Day holiday. [ Editor's Note: As I write this, it is now Friday afternoon before the long weekend as I ponder on the position and the possibilities of a trade.]

What would you do? Do you recognize the possibilities?

Perhaps, from what you have learned, or can be learned from previous posts on this stock market basics site about reading stock charts, the possibilities for a trade can be recognized. The basic patterns in the charts below being related to trends, support and resistance, and the moving averages as potential signal indicators.

Based on what the charts show, you could decide to

• do nothing and continue to hold them
• sell one or two or all of them and perhaps reinvest the proceeds and buy another stock or stocks
• sell one or two and reinvest the proceeds in the remaining stock or stocks

What do the charts show?
The charts show that both MO and MPEL are moving gradually upward with MPEL looking to break through overhead resistance, shown on the chart with a green line, while STX is seemingly continuing in a not too severe downwards trend.

Should we follow the guidelines?
The question is, what should we do, should we hold all three? Or should we sell one or all of the stocks? Our general guideline rule is not to sell the winners unless they are taking too long to make additional worthwhile gains. Another general rule is to add to a winning position as its stock price moves up, and in doing so, we are following the recommendations of one of our favorite stock market advisors, William J O’Neil of the Investors Business Daily (IBD) whose inexpensive books on how to make money in stocks I frequently urge readers to study diligently.

Back to the question and a possible solution
I am contemplating whether it might be wise to sell the STX position and use the proceeds of the sale to increase my position in MPEL. That would mean I would take a small loss in STX and lose out on any of the possible gains that I had calculated should occur when I first opened the position. However, I am writing this on Friday before the long weekend and although I still have time and would like to make the trade, there is another general guideline that comes into play, namely that we prefer not to open a position before a weekend on a Friday and especially before a long weekend.

The reason for that is that we cannot foresee what events, geopolitical or otherwise, might occur during the weekend that might have a negative effect on the market. There have been many times we have seen such a thing happen and the market has opened on Tuesday with a big plunge down. There is nothing expected of that nature right now but the rules are meant to safeguard us as much as possible against the unexpected and if we need it to pay a little more for MPEL because of waiting the extra day or so, that would be OK, we are looking for a gain of at least 20% anyway so there is room for the extra costs if that should be the case.

Note: Click on the charts to enlarge slightly for a sharper view

MO with Moving Averages May 27

MPEL with Moving Averages May 27

STX with Moving Averages May 27

Note: The above charts have the dma (daily moving average)lines added. The 5 dma is in blue, and 10 dma is in red. They are useful to help decide whether to enter or exit a position when the pattern of trading in the stock changes sufficiently to cause a cross-over of their lines, especially if accompanied by an increase in trading volume for that day.

The decision

1. If nothing changes significantly, the decision is to sell STX and add to the MPEL position with the proceeds.
2. Wait to see how MO performs but be ready to sell the position if it falters and use the proceeds to add more MPEL or some other stock that shows promise.

MO is a good stock to hold long-term because it pays a very good dividend, but this stock market basics site is based on a short-term trading approach with the general expectation of not holding a position much longer than 3 or 4 months, less if it is losing.

The value to the reader of this post in describung this potential trade
By outlining a decision on a trade, primarily based on the patterns shown on stock charts, the future outcome which has yet to take place, can be observed by any interested person and perhaps aid them in deciding whether the very popular non-scientific stock chart analytical approach is possibly worthwhile. I think it is — and many traders will not trade without using stock charts. But the art lies in being able to interpret them sufficiently well to make good trading decisions — and by following the established guideline-rules of course. There will be mistakes and losses, every trader experiences them, the guidelines help to minimize the losses and protect working capital for the next venture.

See below the stock charts of the S&P 500 Index and the stocks HAL, MPEL, and HOLX

Here we are in Late May of 2000 and still waiting for the right chart pattern signal to initiate our purchases for our proposed stock market basics paper trading portfolio No. 3, first mentioned more than a month ago. It depends on the right kind of S&P 500 activity for which we also still wait on the sidelines until we see the required breakout signal to the upside. We can see from the chart below that trading is currently confined in a downward channel. However, it also shows the last three consecutive days of gain and a promising upward blip to 1331, now at about the 50 day moving average.

Our next target is to cross through the green line that indicates the 20 day moving average, now at 1337, and to do so in the next couple of days on good volume – that may be our go-ahead signal. After that, the next major resistance would be at the year’s high of 1365/1370, above that there’s “open sky”.

We should also note that the S&P 500 has gained more than 25% from it’s low point in August of 2,010 and although the trend since May 1st has been down, the underlying major up trend since August is still intact — which is what we’re looking for.

Note: Click on the chart below to see a slightly larger and sharper version.

S&P 500 May 27 After the close.

While we wait . . .

As a small trader in the stock market, there are periods of time, like the current one, in which you have to be patient and to wait and continue to wait while the market fluctuates without re-establishing a trend, and therefore not providing a point of entry to start buying stocks. That’s a bit frustrating when you are trying to learn the stock market basics by following chart patterns and by making simulated trades that can provide an understanding of how the market acts on a day to day basis as it reacts to the many external pressures that affect stock prices even though the stocks themselves have experienced no change in their attributes.

We have seen those affects in recent weeks, starting with the geopolitical events in the middle-east, followed by the earthquake, tsunami, and near nuclear meltdown in Japan, then the arguments in the Capitol over the raising of the debt ceiling, and so on, all causing uncertainties, something the market doesn’t like. But to see all of those things happen and to see the effects they do have on the market is of value because, by noting and understanding them, today’s observer will have a better idea of what will happen and how to cope in the future, as a trader, when similar situations occur in the future – as we know they will.

While we await the signal for buying stocks, we can review our now ageing watch list, published April 21,  to see what stocks, if any, can still be considered as near term candidates to populate our proposed paper trading portfolio, and there are a few more to add to the existing list.

With no rush, at this time to get into action by buying stocks, we could also check on some of the fundamental aspects of the candidate stocks, and to do so, I recommend following the William J. O’Neil approach as outlined in most of his several books such as “How to Make Money in Stocks”, published by McGraw-Hill, a book I never get tired of perusing. It’s a quality paperback and I see my 1995 edition cost $10.95 – so it may be about $14.95 now – but a very good investment whatever the price.

3 New charts to examine

Let us look at the charts for HAL, MPEL, and HOLX as possibilities. They are shown here for you to examine and to determine why they might be suitable and what must happen to provide a signal to trigger a stock purchase. And after a suitable time, I can follow up later with my own brief comments answering those questions.

Note: Click on the charts to see a slightly larger and sharper version of them.

Stock Chart of HAL to May 27

Stock Chart of MPEL to May 27

Stock Chart of HOLX May 27

Please Note: Click on the chart to obtain a slightly larger and sharper view

S&P 500 May 16

May 16, 2011
It’s harder to make money when the market is moving down
The chart of the S&P 500 Index, shown above, does not look too promising for those of us now on the sidelines, watching  with me on this Stock Market Basics website and who, like me, are waiting to get into action. We are ready to buy stocks and test our newly learned trading skills – with paper trading.

Our two previous paper trading stock buying ventures, detailed on this site in real-time as they happened a few months ago during September to January, involving AGCO and ASYS, were shown to be very profitable and the have set the stage for our soon to start paper trading Portfolio Number 3.

We are just eager to take a few positions and start buying stocks – even if they are only paper trades with the objective of helping us learn the stock market basics, observing some simple guidelines, and tracking the results of our actions. We want to see how well the “stocks to buy”, that are already listed on our Watch List, will perform in real time on a day to day basis. They will be tested by the real events that, as stock market traders, we cannot foresee but must be prepared to deal with as they occur, supported as much as possible by the simple “house rules” we have established to guide our trading actions.

Warning of a correction?
Depending on a person’s view of the market, the S&P 500 chart could be interpreted as a warning that a correction may be building. The market did close today at 1329 which is below a previous support level, shown on the chart above as a green line at around the 1340 level. This website frequently mentions the importance of breakouts from support or resistance levels that often signal the beginning of a new move in the direction of the breakout until the next support or resistance level is reached.

For the S&P 500, the support levels indicated by the blue rising trendline are important. While it shows the main trend is still upwards, a breakout below the blue line, at around the 1300 level, would seem to confirm a correction taking place.

But maybe not, maybe just a pause on the path of a continued up trend
We will have to wait and see, perhaps the market is waiting for a few additional positive indications. The quarterly earnings season announcements are coming to an end until the next quarter and overall they have again been very good. This is options expiration week (always the third Friday of the month) when stock action often become a little more volatile. And the market does not like the state of uncertainty that exists because of current geopolitical events, the financial problems in the EuroZone, or the U.S. debt ceiling battles and posturing now taking place.

Next major target is above 1470 on the S&P 500
With those uncertainties overcome, the major players should return to fuel an increase in the trading pace. We would look forward to an upward move in the market and a breakout above the 1470 level — marked by the upper blue line on the chart shown above. That is when we can again start buying stocks, monitoring their progress, and giving us something to talk about on the stock market basics approaches to entering and exiting trades.

After choosing the stocks to buy you have to know when to sell them

In a previous post we outlined the stock market basics approach to Buying Stocks now it is time to consider how to exit a stock position based on a stock chart signal or some other logical reason to do so.

Knowing when to enter and exit a stock position is an important facet of stock market trading. The objective of the stock trader is to make money by buying stocks and selling stocks and while success is measured by the number of winning trades and the amounts of money gained from them, it is inevitable that there will also be losses because of losing trades, in fact, probably quite a few.

First, let us consider losing trades
Sometimes losses occur through making bad choices and faulty analysis but in other situations, even the best chosen stocks may be adversely affected by events beyond the trader’s control or ability to foresee, especially geopolitical events or natural disasters like those of recent weeks that have had an impact on the market. Whatever the reason for a losing position, in such cases it is especially important to know when to exit in order to preserve working capital. The “house rule” is to cut the losses quickly.

You don’t always have to be right
It’s great that you don’t have to always be right to be a winner in the stock market – if you know when to make an exit. As I have cited in several other articles on the stock market basics website, quoting the words of a great speculator of the past, Bernard Baruch, who said “Even being right three or four times out of 10 should yield a person a fortune if he or she has the sense to cut their losses quickly.”

When buying stocks and at the time of placing a trade, we should have in mind just how much we expect to gain on the trade, with some latitude, if the stock performs as expected. But in the event that the stock does not perform as expected and actually becomes a losing proposition, we should also know the amount of the maximum loss we are prepared to take and, if that that should occur, we must exit the position without delay or reservation. When it comes to selling a stock in such a situation, so many people become indecisive and hang onto the stock for too long and end up with far greater losses than necessary. An extreme example of that would be in a case such as that of Enron, the famous stock disaster of a few years ago, where many just watched their shares fall almost a hundred percent – and if memory serves me right, I think Enron was a stock that was never indicated as a sell by most of the Wall Street analysts, not that that is unusual.

The actual amount to set as an acceptable loss is a personal judgement decision but well-known professionals — for instance William J. O’Neil of the Investors Business Daily and author of many books on trading and how to invest in the stock market, suggests using an 8% loss from the entry price as the cutoff point at which to exit.

Stops and Stop Losses, essential to minimize risk
It is possible to set a contingent selling price with a stockbroker ahead of time such that at a specific pre-established price, should it be reached, a sell order will be activated, this is called a stop loss and really requires a fuller explanation in a separate article to be posted next on this site. A stop loss can also be implemented as a percentage of stock’s price. Even though a stop loss can activate a sell order, the exact specified price may not always be realized due to market volatility, but it is a useful risk management tool and setting an maximum amount to lose is a must, whether using a mental stop or by an instruction to the stockbroker.

Until learning otherwise, use the 8% rule
As a beginner in the early days of learning the stock market basics, and until personal experience suggests otherwise, the 8% seems to be a suitable loss to take if it becomes necessary. The amount needs to be limited enough to prevent too great a loss in a position that can quickly “eat up” working capital and yet it must be sufficiently big enough to allow for the normal fluctuations that occur in trading throughout the day.

The paper trading portfolio
We are about to start buying stocks for our Stock Market Basics Paper Trading Portfolio 3, as discussed elsewhere on this website, and we will use the 8% as a guideline to exit and of those positions if necessary and see how it affects our results. Although, our objective is to exit with a profit, tentatively set for most stocks at between 20% and 35% if things go as planned.

Now, when in a winning position – what to do?
Knowing when to sell can be a difficult decision when the stock you bought is moving up, it is natural to want to hold on for a little more but anyone experienced in buying stocks knows that an upward move can quickly and unexpectedly reverse itself, sometimes retreating to where the up move started. So the more a gain occurs, the closer the stock market action should be watched. While hoping to see the winning action continue according to the initial expectation of the trade, one should be ready to exit if a significant correction occurs, as it often does, before a stock has reached its expected goal.

There are many factors to take into account, some stocks just perform differently than others, some are more volatile while others are steady and consistent. We will establish some general guidelines here, but experience tells me that knowing where in the life of a moving stock to take a profit is difficult to pinpoint and varies with prevailing conditions and the individual stock’s characteristics.

The initial target gain may be 20 to 35% but things change
As pointed out above, my general expectation and objective is for a 20% to 35% gain when the stock position is established, but conditions can change and previous decisions and expectations may have to be adjusted to existing circumstances. The price pattern shown on a stock chart can be an important reference to aid in determining when to make a move.

For example, in today’s somewhat uncertain market that seems to indicate a readiness to move up but that has stalled in doing so previously, my choice in a stock that has already gained 12% in 60 days was to sell half now and hold the rest to see whether there is another 10% in a continuation of the upward trend after the current pause. The proceeds of the stock sold will provide the stake for any new position that looks promising — and so the cycle begins again, with this one in the winning column so far.

But we can also follow a technical approach, as shown in the chart below as one possible scenario. Meanwhile, I also suggest that the beginner could consult the books by William J. O’Neil mentioned above, for example, my 2002 edition of his “How to Make Money in Stocks”, published by McGraw Hill, devotes a chapter and 15 pages to “When to Sell and Take Your Profit”.

There are indicators, such as the relative Strength Index and the MACD that might suggest or reinforce an exit decision and a selling point might also be signaled on a stock chart by using moving average crossovers, the 5 day and 10 day for instance as shown below in recent trading in HLIT, where the blue 5 day moving average line crosses the red 10 day moving average line on or about April 1, and again on April 29, when a big loss occurred that day, both of those events are indicated by the green arrows on the chart. However, the crossover is really an alert signal, you might wait a day or two to see that the down move is confirmed by its continuing further — which in these incidences it did.

HLIT Chart May 10

Buying stocks
After having qualified a stock as a suitable candidate for trading, the primary entry signals used in the stock market basics approach to trading is to look for a confirmed breakout of the stock price from an existing confining stock trading pattern. For an example, as illustrated in the chart below, a confining pattern on the upside is often a level of resistance established by a previous high or an all-time high. For a downside break the opposite applies, a breakout below a previous low or an all-time low. Breakouts also occur from other recognizable trading pattern formations such as the variously called pennants, flags, triangles, consolidation ranges, cup and handle, measured moves, and so on.

While those are the stock markets basic’s guidelines, there are some patterns that have been shown to warrant buying stocks before a breakout occurs, meaning a larger gain can possibly be captured with little extra risk. One type of stock pattern that would fit that approach is one in which the stock appears to trade within a channel, fluctuating up and down between resistance and support and doing so for several repeated cycles. There are some other patterns that also provide similar opportunities. I will look for examples and post a stock chart or two if I can find them.

Await confirmation if possible
Before buying stocks, when the breakout is relatively minor in its price movement, it is my own inclination to wait for two or three days as a way to confirm that the breakout is real and can be seen to continue on its new trend, and sometimes it doesn’t. But if it does, I don’t think it matters that a few points of gain have been lost. A famous trader once told me that sometimes a stock can be a better buy at a higher price.

Increased volume
An additional positive factor is when a breakout is accompanied by a good increase in the volume of trading transactions, meaning that there is significant increase in demand for the particular stock.

A failed move to the upside
A good example of a recent breakout that did not follow through is that of the much awaited S&P 500 index at 1344 a little more than a week ago on April 26, 2011. After a few days of closing above that level, the S&P reversed and traded lower until it found a new support at about 1335 – which you will notice is the same level as the previous high on April 8, (that is how support and resistance levels can be established, from near their previous resistance and support values). Now today, May 9, we are again waiting for a confirmation of a breakout of the earlier 1344 level, followed by another follow through the more recent level reached on May 2^nd around 1370. So from the chart below it can be seen how those resistance and support levels are established.

Click on the chart below for slight enlargement and greater clarity

S&P 500 May 9

Like sheep?
When other traders are similarly watching for a signal of that type and are waiting to buy stocks, perhaps it becomes a self fulfilling activity, however, experience shows that it does frequently work.

Caution on earnings announcements
The stock market basic guidelines also suggest to NOT buy stocks when earnings announcements are due to be released soon, within the next two or three weeks or perhaps more. On the days when earnings and forecasts for the future have been released, the stock prices can fluctuate considerably and even the best stocks can take a hit if they should miss the analyst’s forecasts by a penny or two. Sometimes it doesn’t make sense but better to be aware of what can happen. For more on the topic of earnings announcements see Earnings Season Starts Now!

Next post – getting out
In our next post we will address an approach to exiting a stock position, preferably with a profit but sometimes with a loss where the objective is to minimize the losses.