With the great response to the article from earlier in the week, Don’t Forget about Past Trades , I would like to expand the conversation.

Any investor can find and research the “greatest” stock on the market; one with huge potential but if the general indexes are negative, it will most likely be the wrong time to buy. A stock with accelerating earnings, rising sales, an up-trending chart pattern and a strong industry group may sound excellent to buy on the surface but will mean absolutely nothing if the market is positioned to move in the opposite direction of your expectations. As soon as a stock is purchased, the time comes for an investor to make a decision to hold or to sell. If the position shows a profit, hold as your judgment is correct. If the position shows a loss, cut it quickly and don’t rationalize the situation before the loss doubles in size. Timing will play an important role in determining if you are right or wrong.

Losers must be cut quickly, long before they materialize into enormous financial disasters. The company and underlying stock may not be a loser but rather your timing may be premature to a strong movement, forcing you to sell on a pullback. After a stock is cut from your portfolio, the transaction must be forgotten about and eliminated from your subconscious mind and/or emotional bank. This may sound as if I am contradicting myself from Monday but I am not. I said the transaction must be eliminated from your memory bank but not the actual trade.

The trade must be studied to capture the true essence of your mistake but the specific security involved must be blocked from any sentimental attachments, allowing you to consider re-establishing the position at another level (most likely higher). This repurchase may take place immediately or well into the future but the important fact is that you were wrong with the timing on the initial position. The timing, also known as the ‘M’ in CANSLIM by William O’Neil, may have been wrong even though all fundamental and technical criteria related to the individual stock seemed to be perfect.

A quote from the great Gerald Loeb:
“Cutting losses is the one and only rule of the markets that can be taught with the assurance that it is always the correct thing to do.”

The wisdom shared by Loeb is easier said than done. Humans like to take profits and hate taking losses or admitting that they were wrong. Pride and ego distorts the clear thinking process that every investor must posses when following clear cut rules that provide insurance to their cash stake. Even tougher, humans refuse to repurchase anything at a higher price that they sold it previously. We are trained from childhood that sales and discounts are they way to make sound purchases. GARBAGE – buy value and opportunity, even if you pay a higher price as long as the risk-to-reward setup is reasonable. As Loeb states, only logic, reason, information and experience can be listened to if failure is to be avoided.

It is advisable to make a “test buy” in a shaky or unstable market which allows the investor to assess the general conditions with minimal risk but still maintain an emotional attachment. If the position goes bad, a small loss will be realize but the damages will be limited and the investor’s pride and ego can be repaired rather quickly. In a sense, the investor was half right by only initiating a partial position also known as a “test buy”. If the market was trending up, a “test buy” would not have to be established as the market direction would have been clear from the beginning.

When it comes to timing, an uneducated investor may realize better gains during a solid bull market based on pure luck than a seasoned investor will return in a sideways or unstable market. Following the trend will be the most successful route to consistent profits over the long haul. By watching the general market indicators, such as price, volume and daily new highs (NH-NL ratio), an investor should know exactly what type of environment they are trading. The most important factor weighing on the stock market is the presence of public psychology, even more so than any fundamentals that the most intelligent academic analyst can compute. Technical analysis along with confirmation of the market trend allows us to see the combined thought process of the general public and tells us if the timing is right to buy or short a specific stock, regardless of the fundamentals.

In conclusion, we must understand that certain situations are only applicable during specific times. Buying leading stocks during a down trend is a sure way to multiple losses that are cut quickly. Shorting stocks during a raging bull is another sure way to financial disaster and margin calls. Don’t get discouraged if you take a few small losses consecutively as your rules and portfolio are telling you to stay out of the market at this time (with this strategy). The timing may be off even though the stock and research is favorable. Why would you swim upstream to reach your destination if you could jump in a boat and row downstream with the current another day? Before you ever start to immerse yourself into researching a stock to purchase, make sure you know the exact environment of the market and determine if it coincides with your objective. If it doesn’t, get ready to get slaughtered, especially if you don’t follow strict rules to cut all losses quickly.

Emotions control our decisions everyday and the greatest leaders and traders learn to harness these emotions and use them to their advantage. As soon as money is involved in a transaction, whether it be the stock market, real estate, art work or antiques; emotions ultimately set the final price. Some investors have greater control over their emotions while other investors are destroyed by their emotional reactions to certain situations and events.

One common trait many novice and advanced investors share, including me, is placing a position in a stock at the wrong time. Years ago, I would study a stock’s chart, the fundamentals, the general market health and everything else that I felt necessary before placing a position behind my beliefs. When things went wrong and I was forced to sell based on my basic stop loss, I would drop the stock from my watch lists and remove it from my memory. This was one of the biggest mistakes that I was making during my earlier years of investing. The greatest investors study their mistakes and learn why they were wrong and have no problem getting back into a stock they just sold if another signal is given. If you don’t learn from your mistakes, you will continue to repeat them and never move to the next level. It is extremely importance to stay focused and emotionally stable when things don’t work out as expected.

I was typically correct with my overall stock analysis but many times I was too early with my entry point. Months later, I would come across the same stock in my screens but it was now up 25%, 50% or more from my initial buy point and stop loss. I was frustrated for selling my stock too soon and was getting tired of using basic CANSLIM sell rules and missing big winners that I sold for an 8% loss.

I knew money could be made on Wall Street using the law of averages to my advantage by employing strong money management skills but I had to become more consistent in my approach and grasp a better understanding of how money management truly worked. I started to practice what I was taught by selling my losers quickly and allowing my stronger stocks to ride their trends. Over time, I was experiencing more losers than winners but my stake was growing because these losers were smaller in size than the winners. The words written by my book mentors were true; Jesse Livermore, Gerald Loeb and William O’Neil were all accurate with their lessons about cutting losses quickly. However, the light bulb didn’t truly shine until I read Trade your Way to Financial Freedom by Van K. Tharp. After reading the book, I became more confident and successful by learning to develop a risk to reward ratio for each trade and by setting detailed position sizing calculations.

More importantly, I learned to keep strong stocks on my radar even if I bought too soon and was forced to sell for a loss. My timing was wrong and my ego was shot because I was wrong, so I typically decided to stay away from that specific stock because it had already taken my cash and my pride. Emotionally, I was burned by the stock even though this was not entirely true. Investing is a game of trial and error. It is okay to buy a stock at the wrong time and sell, only to buy it again because they timing may be better. If you cut the losses small and allow winners to grow, your expectancy will ALWAYS work out, I promise. You must be honest with yourself to allow the averages to work out. You cannot allow a stock to drop past your sell point and you must try to always hold the strongest stocks without selling them during a premature pullback. This all sounds so easy but it is not! If it was so easy, we would all be extremely rich and the stock market would be everyone’s full time job.

It is mentally and emotionally difficult to purchase a stock at a higher price now then it was at an earlier date but it can be the most rewarding strategy. Never look at a chart and toss away a candidate because it has moved up 50% or even doubled in recent months, the real move may just be beginning.

The moral of this article is to make you understand that timing may be your only issue when buying stocks so never throw away a possible superstar because you bought too soon. Keep it on your watch list and be prepared to initiate another position, even if it will cost you an extra point or two. If you buy again and it doesn’t work out; repeat the process as there is always a chance that the stock was not meant to be or your analysis was faulty. In either case, learn what you are doing right and wrong so you can be prepared to use those lessons with the next opportunity.

The basis of this article stems from the teachings of William O’Neil and his CANSLIM acronym.

Stocks breakout from properly formed bases everyday but many investors don’t understand how to locate a pivot point or what patterns to study that may contain this very important buy signal. A pivot point can be described as the optimal buy point or the area at the end of a familiar base pattern where the stock breaks out into new high territory. William O’Neil, the founder of Investor’s Business Daily is considered the pioneer of the pivot point in modern times. As Jesse Livermore explains in his book (1941), the pivot point can also be described as the point of least resistance. When a stock breaks the point of least resistance, we are presented with an opportunity where a stock has the greatest chance of moving higher in a short period of time, especially when volume accompanies the breakout.

The pivot point can be calculated as the stock is forming the handle on a cup-with-handle base. The ideal buy price would be $0.10 higher than the highest spot during the handle, also know as the top of the right side of the base. The intraday high can qualify at the highest point and does not have to be the closing price of the stock. If the stock closes at the high for the day, then we will use this number as the high point.

The exact methods used for finding pivot points vary depending on the base pattern that is forming on a daily and/or weekly chart.

When a flat base occurs, an investor should look for a move $0.10 higher than the top point on the left side of the base or the start of the formation.

A saucer-with-handle follows the same rules as the cup-with-handle and is described in detail above.

A double-bottom formation triggers a pivot point that will be $0.10 higher than the middle peak in the “W” shaped pattern.

Many investors will try to cheat the rules and place a position prematurely before the stock breaks out and passes the pivot point. I do not suggest buying until the stock triggers the pivot point on above average volume also known as qualifying volume. The area considered as the least amount of resistance is weighed so heavily because all overhead sellers are gone as we break into new high territory. The pivot point usually comes within 5% to 15% of the stock’s old high 52-week high.

Don’t chase a stock that is 5% or more above the proper pivot point. This does not mean that you can’t buy on normal corrections and pullbacks to support or moving averages, especially if the stock remains in an uptrend. This rule only applies to the pivot point area as the stock becomes extended. If you buy with the pivot point and sell when a stock falls 5-10% from the pivot point, I guarantee that your yearly performance will increase dramatically. However, your risk must stay within 1-2% maximum of total portfolio value and risk-to-reward ratio should be at least 2.5:1.

How to Look for a Cup with Handle (chart #1):
Look for relatively quiet volume as the stock builds the left side of the cup. Volume at the base of the cup should be slightly higher than the left side as support is coming into the stock. The right side of the base should have above average volume with more up-days than down days. The handle will be the last part of the formation and should slope slightly downward with lower volume than the right side of the base. The pivot point will be slightly higher than the highest point of the right side of the base. All breakouts should occur on volume 100% greater than average daily volume although IBD does say that breakouts above 50% do qualify.

How to Look for a Saucer with Handle (chart #2):
Look for relatively quiet volume as the stock builds the left side of the saucer. A saucer looks similar to the cup-with-handle but the dip from the high to the low is smaller and usually longer in duration. Volume at the base of the saucer should be slightly higher than the left side as support is coming into the stock. At this point, the base may almost qualify as a flat base. The right side of the base should have above average volume with more up-days than down days but this does not have to be as prominent as the cup-with-handle. The handle will be the last part of the formation and should slope slightly downward with lower volume than the right side of the base. The pivot point will be slightly higher than the highest point of the right side of the base. All breakouts should occur on volume 100% greater than average daily volume.