Saturday, July 17, 2010
Over the weekend, I was doing some reading and stumbled onto this quote:
"The idea that there is a single, “correct” casting motion is one of the great fallacies in fly fishing. Spend enough time at the casting pool at a consumer show, and you'll see several big-name instructors make the case that their method is better than the rest. Truth is, they're all wrong. What works for your buddy might not work for you at all."
The same statement can be said about Entry signals for stocks. Some people may feel more comfortable buying during a pullback, others at new highs. Your buddy might love the fast pace of day trading, where you find it dizzying. What works for one person may not work for another.
The entry signal is one way to control your risk on any given trade. Based on the your conditions, your risk to reward will adjust accordingly.
For instance, buying closer to a moving average cross-over such as a 5 day SMA crossing a 20 day SMA will be a lower risk entry compared to buying a six month high.
The Entry is just one part of the entire trade. Combine entry with a market timing mechanism, risk management and an exit strategy and only then will you start seeing consistent returns.
For me, the goal of the entry signal is to narrow down all the stocks found in my watch lists. Of the 200 or so stocks tracked each day, I will only see a handful of entry signals. These stocks present the lowest risk entry across my pool of stocks which are already filtered on things like liquidity, momentum, sector strength and value. At that point, it's just either a decision to buy or not buy.
I don't know about you, but I like to use research driven strategies that have published proof of their performance. Crazy concept eh? Listed below are three examples of research driven entry signals.
Top 25 Break-Out - Stockbee
The StockBee breakout is the Entry signal I have used since 2007. The StockBee Top 25 Break-Out has 3 attributes: Price Percent Change, Volume, and Liquidity.
This breakout has an edge because you can catch a large move from the start. After researching 40 years of data, Pradeep discovered that most major moves start with a 4% price change, on higher volume. There is no dependency on a new high, or waiting for a slower time-based trend crossover to occur.
Pradeep has been using this break-out for over 10 years. Don't think it works? Check out the performance spreadsheet over at the StockBee site.
Cirrus Logic, Inc. (Public, NASDAQ:CRUS) - Top 25 Break-Out signal
N-Day Break-Out - New Trading Systems and Methods, Perry J. Kaufman
This is a pretty straight forward system. You buy when the current price reaches the highest level across N number of days. The version found on the Stockfinder template also has a volume and liquidity check. What can I say, it just didn't seem right to not have those on there :) N is set to 32 days.
Cirrus Logic, Inc. (Public, NASDAQ:CRUS) - N-Day Break-Out
Donchian's 5- and 20-Day Moving Average Crossover
This type of system waits for the faster trendline (5) to crossover the slower (20). You can either buy when the price crosses above both moving averages or you can wait 1,2,3, days for a confirmation of the move. This leaves a little more wiggle room to each trade. Not for me, but other people might like the flexibility.
Dave Landry refers to a similar trade in his book, 10 Best Swing Trading Patterns and Strategies. He describes his Bow Tie trade using a 10 day sma, 20 day ema, and 30 day ema. The moving averages should have been shifting from a downtrend to an proper uptrend order (10ma > 20ma > 30ma).
Stockcharts.com has detailed explanation of how simple and exponential moving averages are calculated.
Cirrus Logic, Inc. (Public, NASDAQ:CRUS) - Moving Average Crossover
One final note, none of these signals will work when the market is in a downtrend. You need an uptrending market for these methods to work.
I have added these to my Stock Finder shared layouts -
Layout Name: PatientFisherman_EntrySignals