…Let’s start by saying: “You can’t be afraid to take a loss”. The investors that are the most successful in the stock market are the people who are willing to lose money.

Having a strategy and/or a specific philosophy is an excellent starting point to investing but it won’t mean a thing if you can’t manage your money. As I have said a million times: “without cash, you can’t invest”.

Most investors spend far too much time trying to figure out the exact pivot point or perfect entry strategy and too little time on money management. The most important aspect to investing is cutting your losses, 90% of the battle is won by protecting your capital, regardless of the strategy.

Most successful money managers only make money 50-55% of time. This means that successful individual investors are going to be wrong about half the time. Since this is the case, you better be ready to accept your losses and cut them while they are small. By cutting losses quickly and allowing your winners to ride the up-trend, you will consistently finish the year with black ink.

Here are some methods that can help you with money management:

• Set a predetermined stop loss (you must know where to cut the loss before it happens – this will help control emotions when the time comes). A 7-10% stop loss insurance policy is best. Tighten the stop loss range in down markets and loosen the range in strong bull markets.

• Establish smaller positions if your account has had a recent losing streak (the losses may be telling you important information such as a critical turning point, it may be time to sell and get out).

• If you think you are wrong or if the market is moving against you, cut your position in half – this is the best insurance policy on Wall Street.

• If you cut your position in half two times, you will be left with only 25% of the original position – the remaining stock is no longer a big deal as your risk is very low.

• If you sell out of a trade prematurely based on a minor correction, you can always reestablish the position again.

• Initial position sizing plays a big part in money management – don’t take on too big of a position relative to your portfolio size. Novice investors should never use their entire account on one trade no matter how small the account.

• Know when you would like to get out of a position after a considerable profit has been made. Signs of topping could be a climax run, a spinning top or higher highs on lower volume.

• Finally, cut any trade that doesn’t act the way you originally analyzed it to act.

With these guidelines, you will be well on your way to solid money management skills that will help you profit in Wall Street year in and year out. Always remember, you are going to take-on losing trades at least half of the time. This is a tough concept to accept for most novice investors but it a fact. If you don’t cut losses, you won’t be investing for very long as you will run out of cash and the desire to continue to invest.

Piranha

…I was recently asked about a chart pattern that boasts tight closes at some point in an uptrend. William O’Neil actually named a pattern after this type of market action “three weeks tight”. As I mentioned, the pattern usually forms as the stock has already broken out of the original base. The pivot point is usually long gone but this pattern allows the investor to establish a new position or add to the first position.

You must use a weekly chart to see this pattern as the daily charts will have too much volatility and unnecessary noise that will only confuse you. Look for a stock that has strong fundamentals and has started to stall, closing in a very tight range for at least three weeks. The price will close at almost the exact same point each of the three weeks.

The stock may swing from its weekly high to its weekly low intraday but the most important number is the close at the end of the day on Friday. Make sure the stock doesn’t break any long term support lines such as the 50-d or 200-d moving averages. If the volatility is not excessive, the buy can be considered. After the stock closes the final week (week #3), you may add a new position but make sure you buy a smaller amount of shares than you would at the proper pivot point. If the trade turns bad, always sell and sell fast, cut all losses at a maximum of 7% on this pattern.

Always keep in mind that tight closes in both the daily and weekly charts may provide a clue that institutional investors are buying up shares as the weak investors bail. These institutional investors are holding up the stock as the three week pattern forms.

Another similar pattern is the “railroad-track pattern” which typically occurs near the top of a climax run. If the stock closes the week slightly higher on above average volume, issue a mental red flag. On the weekly chart, this pattern will resemble railroad tracks by closing with two parallel vertical lines. The three week tight pattern is positive while the railroad track pattern is usually negative.

Piranha

…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 highest point can be the intraday high and not always the closing price of the stock. If the stock closes at the high for the day, then we will use this number. We look for the ultimate high on the beginning stages of the handle.

The exact methods used for finding pivot points vary depending on the base that is forming.

On a flat base, you would 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 would follow the same rules as the cup-with-handle.

A double-bottom formation would set the pivot point at $0.10 higher than the middle peak in the “W”.

As I mentioned in the previous blog post, we do not buy until the stock triggers the pivot point on above average volume also known as qualifying volume. This is the area where the stock faces the least amount of resistance as 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. Try not to buy a stock after it is 5% above the proper pivot point. This does not mean that we can’t buy on normal corrections and pullbacks as the stock remains in an uptrend. The rule only applies to the pivot point area as the stock becomes extended.

Piranha

A great question was asked through e-mail by one of our fellow members:

Why wouldn’t you purchase ELOS now before the right side of the base is finished forming?



A stock must finish the base before it is bought because most stocks that don’t finish the base continue to trade sideways for months or years or start to breakdown as the speculators bail by selling their positions. The line of least resistance or the pivot point is the best place to buy as the stock is breaking out to new highs. Remember, many people bought ELOS at the top of the left side of the base near $39.

These investors have suffered through paper losses waiting months to sell at break even which would be at or near the top of the right side. When the price nears the old high, most weak holders will sell out happy that they broke even. This selling action usually occurs in a week’s time thus forming the handle and shaking out weak investors on lower volume.

After the institutions see that these weak holders have sold, the real party starts with a breakout on above average volume – the pivot point. Once the stock breaks out and goes on to a new high, there are no more sellers because the stock has never been in this territory. There is no resistance above this pivot point.

This is why we wait to allow the stock to prove itself and buy properly at the pivot point. ELOS may never complete the base but if it does, I will post the precise pivot point and volume levels needed to qualify.

Finally, if you buy ELOS now, it would be pure speculation and your risk levels would be raised based on history. I would prefer to buy higher when there is lower risk of a breakdown because stock holders might want to sell old positions from the left side of the base. In addition, the current market is in correction mode giving us more reason to wait for this base to form properly, keeping our risk lower than it is today.

This was an excellent question and I hope many of you learn and study past breakouts to understand this rule better.

Piranha