I am often asked how I determine entries and exits for my trades. Let’s take a look at a real time example and walk through the process. As I write this, it is 11:00 AM New York Time on Tuesday June 19, 2007.
First and most importantly, I determine how much risk I am willing to take on a trade. My preference is to limit risk to 1-2% of my portfolio. In this example, I will use a portfolio size of $50,000 and limit the risk to 1%. So that means I am willing to only lose $500 on a trade (1% of $50K).
Next, I search through my favorite stocks to see if any of their charts look appealing. I like stocks that are either breaking to new highs or breaking their downtrend lines. Since gold is overdue for a run, let’s take a look at Central Fund of Canada (NYSEMKT:CEF). It’s a gold and silver bullion fund and one of my favorites.
Today it is breaking its downtrend line and its MACD is in a bullish formation - black line above the red line. So, the chart is looking good. I also like my stocks to have momentum. Most times I will wait until the last half-hour of the trading day to make my purchases. If I stock is still going strong at the end of the day - it “might” follow through on the next day. There is nothing more discouraging than buying a stock and watching it drop immediately after purchasing.
This strategy also helps minimize your emotions. Fear and greed have driven the market forever and will remain doing so until the end of time. To be a successful trader one must learn to keep their emotions in check. I find that by limiting my buying window - I am less likely to get caught up in the euphoria of the day. The final buying criteria is that the stock’s price must be higher than its opening ($9.24) and yesterday’s close ($9.23). That serves as additional confirmation that the momentum is on our side.
Finally, we need to determine how many shares to buy. CEF has bounced off $8.90 three times. A good place to put a stop would be a few pennies below $8.90. Let’s use a stop of $8.87. CEF is currently trading at $9.29. Let’s assume that is still trading there at 3:30PM. If that is the case, our stop would be 4.7% ($9.29/$8.87) from the entry. Since we are limiting our loss to 1% overall, the most that we could allocate to the trade is 21% (1/.047). Therefore, we would commit $10,500 to the trade or 1,130 shares.
The bases are now all covered. We have identified and limited our risk. The charts and momentum are on our side. So, all we can do now is pull the trigger and hope that the market does its job.