Anatomy of a Stock Trade: Entry Techniques

I received an email from a subscriber asking for my opinion on when to enter a trade.  Do I prefer to wait for pull-backs or buy new highs?  Before I answer, let’s take a look at the different elements of a trade.

I believe that there are 3 elements to each trade – Entry, Exit and Risk Management.  According to Van Tharp in “Trade Your Way to Financial Freedom,” he estimates that 95% or more of the people attempting to design trading systems concentrate on finding a “great” entry signals.  He goes on to say that the entry only plays a small part in making money trading.

Your exit strategy is far more important than your entry, but amazingly most people don’t even think about it.  In a previous article, I  discussed the “sail-boat” mentality.  Most buy a stock with the intent to sell it down the road and then sail off into the sunset hapily ever after.  I never enter a trade without knowing the price that I will fold ’em.

The third element, risk management, I believe is the most important.  It’s plain and simple if you want to make money in the market you have to stay in the game.  You gotta be in it to win it!  It takes a long time to realize that taking small losses are a necessary evil.  Your next trade could be the big winner, but if you were just wiped out by a large loss – what difference does it make?  I will talk more about risk management at a later date.  Now back to entry techniques.

I use both pull backs and new highs as entry techniques.  Let’s take a look at a couple of trades from my Real Money portfolio.

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Buy 1 is an example of buying a pullback.  I didn’t buy the absolute low.  When the stock was at $36, it looked like it was on its way to $30.  Instead, I bought it when it broke its down trend line.   I want my stocks to have upward momentum.  If they don’t take off right after I bought it – it was probably a mistake.  Note – The down trend line looks a little weird, because the data on the left was cut-off. 

I used a break of its up trend line as my exit.  If I was lucky I could have sold at $46.5.  However, I believe in letting your winners run.  Sometimes you give up a few percent, but profit taking for profit taking sake is not my style.  That trade netted 8.9% in a little over 5 weeks.  That may not sound like much, but imagine doing that every 5 weeks.

I repurchased BHP on March 21.  This time I bought it when it made a new closing high (NCH).  In other words, its close exceeded a previous closing high.  My preference is to purchase stocks at the close of the day.  Once again, my objective is to purchase stocks with upward momentum.

So far so good with this latest purchase.  As of April 13, the trade is up 6.9%.

My final example is a trade I made a couple of days ago (April 12).   This was not in the Real Money portfolio, but in one of my other portfolios.  I admit that this is a fairly risky trade considering PBR’s vertical move over the past month.  On April 12, PBR pulled-back to its trend-line and made a NCH on the same day.  A combination of my two favorite entry techniques. 

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I have a stop at $102 if the trade falls apart.  Let’s see what happens. 

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