How to Trade Short stocks BUY SELL Trading
Post on: 23 Июль, 2015 No Comment
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FOUNDATION OF PROFIT FROM PRICES SIGNALS
As such, the Open, High, Low and Close prices for a day are just plain figures/numbers. Most people are unable to extract any useful information from them so it is not surprising to see them totally ignore Open prices and also High and Low prices often times. As I will show you in next few chapters, the four daily/weekly prices and trading volume numbers contain tremendous amount of information and it is not a complex science or math to extract and use it for trading stocks.
In this book, I am going to show you how simple it is to read between the lines when you compare today’s four daily prices and trading volume to that of previous two or three days. Though the modern investment world has started ignoring Open prices, it is a very important number when it is compared to previous day/week’s Closing price or with the current day/week’s Closing price. For me Open price is a valuable number to assess overall sentiment when market opens. Similarly High and Low prices tell me how sentiment behaved during the session. Throughout my trading signals, I refer to two primary tests. I run these tests daily to monitor how the market sentiment and Demand and Supply are changing. Then I add some more tests to these two basic tests to quantify strengths of such changes and to figure out trading implications. Here is my two main tests:
- What happened while the market was closed, or the stock was not trading? To answer this question, I compare Today’s Open price (TDO) to the Previous Day’s Close (PDC) price. If Today’s Open price is higher than Previous Day’s Close price, it tells me that there is a change in investor sentiment, and the change is for better. Whatever happened overnight, while the market was closed, it has resulted in positive implications for the stock prices today: It has caused Demand to increase and/or Supply to dwindle. Why would buyers pay higher prices today for the same thing that was available previous day for less? No one in the market system wants to pay a penny more for the same thing! This is even more true for stock market. This happens only when someone is convinced of a bigger profit down the road than the additional amount he is paying in terms higher price! For this reason, I take a strong Open price in a stock as an indication of improvement in investors’ sentiment toward it. (The reverse is true when Today’s Open price is lower than Previous Day’s Close price).
There is one caveat: Only a strong Open is not sufficient reason to buy any stock. It does indicate improved sentiments but it is only half of the story. Improved sentiment has to result in higher demand and hence higher prices. This can be confirmed only after watching the full day’s trading. So for this, I have a second test.
As I said earlier, these two tests though they provide useful information are not sufficient for entering into any trading position. So I have few more tests to help us be more confident. When I explain various signals in the following chapters, I will show you these supplementary tests/conditions that take us few steps further and give us some quantitative information: how significant is the change in sentiment, how long it is likely to last, and what we should do to take advantage of it.
PROFIT FROM PRICES TRADING SIGNALS- AN INTRODUCTION
In this book, a signal is an indication to buy, sell, book profit or book loss. There are various signal as we will see in the next chapter: U-TURN, FREE FALL, REVERSE etc.
Every signal in this book will have typically following components:
- Versions- Buy Versus Sell. As we know, there are two types of trends in stocks- Bullish or Bearish. Similarly, a stock can be traded in two different ways- Buy or Sell. Hence every signal in this book will be discussed in these two opposite circumstances- to generate a BUY signal or a SELL signal. First, we will see how to apply the BUY version of the signal to capture stock trading opportunities by going long (buying the stock). Such version of the signal will be labeled with suffix (BUY) because it gives a Buy signal. Then we will discuss the same signal in the reverse market conditions to identify ‘Sell’ signals. We will suffix them with (SELL). (BUY) signals can be used to close/cover existing short positions and/or to initiate fresh long positions. Similarly, (SELL) signals should be used for closing existing long positions and/or to initiate fresh short positions. As an example, U TURN is one of our signals. It will have two versions: U TURN (BUY) to give us buy signals and U TURN (SELL) to give us sell signals.
- A set of tests/conditions: A signal can have from two to up to ten tests (conditions). When all or most of the tests are fulfilled (are true) for a given signal, we have a trading signal. An example of a condition or a test is- Today’s Open price is lower than Previous day’s High Price. Another example is- Today’s Low price is the lowest price over last three to five days.
- Action: Every signal has some specific implied action- to buy, to sell short, to cover a short position or to sell a long position.
- Stop-loss: Every signal has a stop-loss. This is like an expiry date printed on most of the perishable items we buy in grocery stores. As time decays most of the food items, it also decays a signal. However unlike expiration on a specific date for a food item, a signal expires at a specific price level. This is called stop-loss about which we have already seen in the previous chapter. Our signal few days back might be a powerful one, but subsequent developments may have adversely affected the stock price. If there is some news or some people are suddenly dumping the stock, our trading has to consider this. Because our signal told us to buy, we should not blindly stick to a position. So when the stock price crosses the stop-loss level, we take it as a failure of our signal. Every signal we will discuss will have this component.
HOW GOOD IS OUR SIGNAL?
From the next chapter, we are going to look at individual signal. Some of them are very powerful for short as well as long term trading and some are good mostly for taking advantage of only the next few days’ price movement. Every signal I use is unique- it has specific set of tests, prerequisites and implications. Before we get into individual signal, let us look at the factors that make a signal weak or strong.
www.yahoo.com or in most brokerage websites. Any aberration in trading will stand out there on such charts.
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- Stop-loss: PFP signals are very timely. They tell us on the day a material change in sentiment or demand-supply is taking place. However as you know, stock markets are not static. There is always something happening- economical, political or company-related news or developments. So even if there was an indication (signal) of powerful buying yesterday, it is likely that something might have turned the battle in favor of sellers again. It might be some negative comments or a downgrade by some stock analyst, some news report or it could be a company press release. Sometimes, the buying we felt may be just a spike- a one-day event. Such things can cause the signal to fail. As you know, markets are too dynamic for any person or system to make any perfect prediction.
So what do we do in such situations? Any Buy signal we get is good as long as the stock price stays above the low price of the last one to five days (we call it stop-loss level). Similarly a Sell signal is good as long as the stock price stays below the high price of the last one to five days (I will narrow down this range to a specific number when we discuss each signal individually). So after buying a stock when it goes below this low price (stop-loss), we should close the position. Every signal is good as long the prices are in our favor. However when the stock price crosses the stop-loss, it means just one thing: our signal has failed. It is time to close the position and watch for another trading opportunity. We listen to the prices; we do not argue with them. After a Buy signal, when the stock trades below stop-loss, prices are telling us that sellers are still ruling and are in command. It is time we withdraw ourselves. It is okay to be on the losing side in a real battle for some grand cause; but stock market battle is always for money and we have freedom to switch parties. If we see buyers losing battle, why should we stay with them?
HOW TO ACT ON A SIGNAL
After we get a trading signal in a stock based on current prices, when should we trade? We have four choices as such but there is no science or an exact answer. What works good for one might not work as well for others. So one should take into consideration various factors, current trend, nature of the stock, etc. to make a decision.
- Trade Now: This alternative tells us to make a trade as soon as we have a valid signal in the stock. This is the normal thing to do in most situations.
- Wait for a Pull-back: Most of the times, we will get a buy signal after a very good last trading day or a sell signal after a bad day. Sometimes it is possible that price may have gone up or down significantly on the day of the valid trading signal. So we have a choice here: Instead of taking an immediate action at the Open price of the next day, we can wait for the stock to come back a little over the next day or two (We call this Pull-back in prices). If you decide to wait, you should be aware of the risk in this choice. It is likely that the stock may not get as much pull-back as we might have expected. So for a trade at a more favorable rate, we risk to miss the profit opportunity signaled by our trading system. As always, there is no free ride or lunch in financial markets.
When should we wait for a pull-back? In certain situations, it does make sense to wait for a pull back. Let us look at certain situations: (1) If we have a strong buy signal in a stock when most similar stocks or the market as a whole is going down, it may turn out to be a wise decision to wait for a pull-back in order to buy it little cheap. Similarly for a Sell signal, if most other stocks or the market are in strong up-trend, it makes sense to wait before we jump immediately in response to the sell signal and short it. (2) Sometimes there is a significant price movement on the day of the signal. Say a 10$ stock jumped 2$ today and gave us a very strong buy signal. It is also likely that the next day the stock could open up in a gap at 12.50 to 13.00$. So instead of buying this stock at such a high price, we can wait the stock to come back to around 11$.
How much pull-back should we wait for? So if you decide to wait for a pull back, let me tell you my rule- For a buy signal, I go with a limit order with the limit at the average of (low price of the last two days, high price of the signal day). So if the low was at 10$ and the high on the buy signal day was 12$, I would keep a limit order to buy at 11.01$ (I like to buy at 1 cent above the round number and sell at 1 cent below any round number). Similarly if I had a strong sell signal for the stock which made a recent high at 22 dollars but made a low of 20$ on the signal day, I would keep a limit to sell it around 20.99$.
When should we wait for a confirmation? Many times, reversal signals we get are due to one-day aberration in prices or a reactionary trend in the main trend. Such signals often fail. So as to save us from entering in and out at a loss, we can wait for the stock to demonstrate favorable price movement over the subsequent two to three days before we actually buy it. When does this waiting for another confirmation is a good decision? In certain situations, it does make sense to pay a higher price for what we are buying (or get a lower price for what we are selling). Let us look at certain circumstances: (1) If we have a strong buy signal in a stock when most similar stocks or the market as a whole are going down, it may turn out to be a wise decision not to immediately jump on. We can doubt the reversal given by our signal unless we see higher prices over next two to three days. Similarly, for a Sell signal, if most other stocks or the market are in strong up-trend, it makes sense to wait before we jump immediately in response to the sell signal and short it. Let us make sure the prices are really going down.
How long should we wait for? So if we decide to look for another confirmation for the reversal, how should we go for it? It is very difficult to answer this question. Let me tell give some guidelines. For a buy signal, we ca go with a STOP LIMIT order at 1 to 2% above the high price on the signal date. So if the High price on the buy signal day was 12$, I would keep a limit order to buy at 12.21$ (I like to buy at 1 cent above the round number and sell at 1 cent below any round number). Similarly if I had a strong sell signal for the stock which made the low of 20$ on the signal day, I would keep a STOP LIMIT order to short sell it around 19.79$. What is a STOP LIMIT order? A buy Stop Limit order for a stock currently quoting at 11 dollar is to buy the stock at say 11.45$ or lower ONLY AFTER it has traded above the Stop price of say 11.31$. Please make not that the Stop price as well as limit price both are usually higher than the current price. A sell Stop Limit order for a stock quoting at 20$ might look like to sell the stock at 19.70 or above only after it has traded below out Stop price of 19.79 or something like that. Another version of STOP LIMIT order is a STOP MARKET order. Here, there is no limit but just a Stop price. As soon as the stock trades above (below) the Stop price, our Buy (Sell) order becomes a market order.
SIGNAL TERMINOLOGY
PRICES: The first character is optional and assumes T for Today, P for Previous, Q for the day or week before previous.
- 1. The first character is optional and assumes T for Today, P for Previous, and Q for the day or week before previous.
- The second character assumes one of the following values: D for Day, W for Week and M for Month.
- The last character takes a value based on what price it is: O for Open, H for High, L for Low and C for Close.
Here is a list of acronyms that would be used throughout the book. They are easy to remember.
TDO = Today’s Open price
TDH = Today’s High price
TDL= Today’s Low price
TDC= Today’s Close price
PDO= Previous Day’s Open price
PDH= Previous Day’s High price
PDL= Previous Day’s Low price
PDC= Previous Day’s Close price
TWO= This Week’s Open price
TWH= This Week’s High price
TWL= This Week’s Low price
TWC= This Week’s Close price
PWO= Previous Week’s Open price
PWH= Previous Week’s High price
PWL= Previous Week’s Low price
PWC= Previous Week’s Close price
Similarly replacing P above with Q would give us respective prices for the day or week before previous. So QWO means the Week before Previous Week’s Open price.
QWO= Previous to Previous Week’s Open price
QWH= Previous to Previous Week’s High price
QWL= Previous to Previous Week’s Low price
QWC= Previous to Previous Week’s Close price
Please see in the weekly price table above, what these symbols mean. These symbols are put next to weekly prices.
BULL DAY: A day in which a stock has the Closing price higher than the Opening price is called a BULL DAY. What is the importance of this? It is a quick method to know what happened during the day. A Closing price higher than the Opening price does indicate that the Demand was more aggressive during the day than the Supply. This fact taken by itself does not give solid information but when combined with other tests, it is powerful supporting evidence.
BEAR DAY: A day in which a stock has Closed lower than its Opening price. It indicates that during the trading day, the Supply was more powerful/aggressive than the Demand. It is a negative indicator for a long position. Like a BULL DAY, this assumes greater importance when it is used with other indicators. Nonetheless it is important to know what a BULL DAY and a BEAR DAY mean.
Candlestick charts: While explaining various signals, I am going to use Candlestick charts. So let me take few moments to show you how to read various daily prices on a Candle Stick chart. Unlike traditional stock charts that are either a line chart of the Closing stock prices or a bar chart, a Candlestick chart has all four prices, Open, High, Low and Close, reflected.
A candle (a day or a week’s prices) has two parts: It has a body and two lines attached to it. The high point of the UPPER LINE is the High price for the day or week or the month depending on the chart you are looking at. Similarly the low point of the LOWER LINE is the Low price. The upper and lower points of the BODY reflect Open and Close prices depending on the type/color of the candle. The body is either filled (dark) or empty (white). Please see the chart below. When the body is filled (dark), the upper edge of the BODY (and not the line) is the Open price and the lower edge is the Close price. In other words, when the Closing price is lower than the Opening price, the body is dark to indicate that it was a BEAR day. Similarly when the body is empty (white), the upper edge reflects the Closing price and the lower edge reflects the Opening price. So such empty (white) bodied candles mean a BULL day, reflecting the fact that the Closing price was higher than the Opening price.
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See a Candle Stick chart below for better understanding:
Now you are ready to explore some of my signals. These signals are divided into two groups: Trend Reversal signals and Short term trading signals.
Trend reversal signals have long term price implications but they can also be used for short-term trading (3 to 10 days). Short-term signals are mostly for short-term trading positions lasting from 3 to around 10 days.
