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Trading Improvements

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PostPosted: Sat Nov 19, 2005 5:56 pm    Post subject: Trading Improvements Reply with quote

Most large institutions, e.g. mutual funds, pension funds, insurance firms, and many hedge funds, typically buy momentum stocks and use stops. However, most of these institutions underperform the S&P 500 over time, in part, because when they buy these stocks most of them will underperform after they buy and the use of stops will create more losers than winners.

The PeakTrader approach buys stocks or options based on high return to risk ratios and focuses on the safest stocks. Moreover, PeakTrader uses volatility (rather than momentum or stops) to capture gains. Consequently, most of the PeakTrader top stock picks are high quality stocks that have been in downtrends, which have become fundamentally or relatively severely undervalued compared to the market or other stocks.

Safety is paramount.

Each day, there's always a best stock. However, that stock may become better the next day.

The PeakTrader option portfolio has been flat for two weeks, after it rose in the previous weeks, although most of our top stock picks turned out to be winners. So, some review and adjustments may be needed to improve returns. The goal of PeakTrader is to help our members earn 100% returns each year consistently, i.e. without excessive risk.

Overtrading typically lowers returns. PeakTrader reduced the use of buying and selling spreads (i.e. placing "automatic" limit buy and sell orders for greater executions), which has resulted in 15 to 20 trades a day instead of 25 to 30 trades a day, on average. This has improved returns, because although many winning trades didn't take place, many losing trades also didn't take place. Moreover, this change has been a net benefit, because fewer trades are required to make gains in a low volatility market.

However, 15 to 20 trades almost everyday is still a lot. A better approach may be to wait for rare excellent opportunities, and then make larger trades. However, this requires a great deal of discipline, i.e. sitting in cash or holding a stock or options for weeks or months, watching the market, and missing lots of money making opportunities. Nonetheless, when the excellent opportunity shows up, you'll know it, and that's the time to make a bold trade. This approach may result in perhaps only a dozen trades a year. However, I suspect, 100% annual returns will be more likely achieved (perhaps on the first few trades each year).

PeakTrader has an excellent track record, over the years, of timing stocks, although far from perfect. Over the past few weeks, for example, our winning timing stock picks include (see first page of Top Stock Picks section): WMT DD DOW GM F X AKS CBJ HL PCLN TWX MSFT IR PFE BMY MRK GP AMCC TYC PMCS OEX CVX JBLU LUV CEGE for longs, and OIH for shorts. There have also been losers over the past few weeks, i.e. LU PPH OSIP TARO SNDA for longs and GOOG for shorts. Moreover, there were few stocks that were basically neutral.

PeakTrader has also been accurate predicting the general market. In October, it seemed, most expected the market would continue to fall (for example, almost everyone on the StockCharts Public Chart List were bearish at the market low). However, PeakTrader correctly predicted a rally, the support level, of the low, and the timing of the support level, in October. Moreover, PeakTrader correctly predicted the previous top and resistance level, and the directions of oil and bonds.

Nonetheless, many trading improvements can be made. Some of our daily top stock picks are "borderline trades." Some became big winners, while too many became big losers. Borderline trades will be removed from the "Top Stock Picks" section. Consequently, there may be only a handful of top stock picks each day. However, this may result in fewer trades, which should be beneficial.

We often sell too soon the stocks we're most sure about. When OEX DD DOW WMT X and MSFT fell to low levels recently, we bought heavy positions in calls. However, we sold too soon, and those stocks continued to rally much higher. Also, when SPX IWM TLT and OIH rose to our target highs, we bought heavy positions in puts, and sold too soon. We stopped following most of these big winners after we sold. So, we'll need to continue focusing on them, for possible reentry points, or also buy positions in longer-term options for longer trades.

However, not all stocks we were most sure about performed the way we expected. PFE was a buy at just over 21 recently, because it had heavy volume for a week while the price held steady indicating it would rise. Also, PFE's cash flows, forward P/E, bond quality, etc. indicated it was undervalued. PFE did rise to just over 22 1/2. However, it then fell back to below 21 1/4. So, it didn't rise much. Nonetheless, PFE fits the safety criterion, and remains a long-term buy.

Over the past 15 months, GOOG has risen from 85 to over 400, reaching a market cap of over $112 billion. Most valuation models would peg GOOG's share price well below 200. GOOG has had strong earnings growth from only one property, the search engine. GOOG has risen with SPX recently. While SPX rose from 1,168 to about 1,250, over the past month, GOOG rose from below 300 to above 400. However, internet stocks typically tend to be unpredictable. So, it may be wise just to avoid them altogether.

GM was a perfect short-term trading stock recently. GM fell below 23, bounced to about 25, then fell below 21, and bounced above 24, all within seven trading days. The qualities that made GM a perfect short-term trading stock was it's low market cap, which is less than 1/10th the size of PFE's market cap, making it volatile, the steep fall on fears of bankruptcy, which is premature fundamentally by years, and it's one of the Dow Jones components, where index funds must maintain a fixed number of shares. GM continues to be a buy on pullbacks.

In summary, focusing on fewer stocks for longer periods of time (which may include buying longer-term options), restraining from questionable trades, and staying heavy in cash, until excellent opportunities appear should improve returns. Consequently, your market and stock timing should improve, and the overall position of your portfolio will be better when the market moves. When the market becomes more volatile, there will be more excellent short-term trading opportunities, similar to the GM example.
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