Today’s sell off just confirmed my concerns regarding the market and possible addition to AFAM. This post is to finish my view at this stock. On some other web sites investors can read analysis about certain stock with possible future outlook, but then none of the web site comes back to the stock to revise their view based on the new market action. At least I couldn’t find any such web site. Even IBD which is providing very good reports and analysis gives you a view at a certain stock but next day the situation may become very different from what the report said. Once I read a stock report on FSLR which at that time was supposed to finish a cup of handle pattern, but market had changed and FSLR went down. I know that every investor shall perform his own research and all such reports shall be considered at maximum as recommendation. However sometimes further look at the stock by an experienced investor, trader or professional providing reports would be very helpful to any beginning investor. Such continuation can help to see more behind the stock movement.

This is why I am finishing this miniseries about AFAM because as per today I have made already my decision on this stock. If the market would be in a rally it would be easy to add more shares to the existing positions. The stock reacted well and as expected for a short correction. However today the stock was driven further down by the entire market sentiment, so adding new positions would be very risky. The positive thing is that the volume was low. It was still higher than average, but it is slowing down. The volume with the stock’s movement makes me wait for further development without taking any action. If the stock will touch my stop loss, I will sell. If it will go down, side ways or slowly up, I will sit tight waiting for it and buy new position when the price touches my first target price for pyramiding.

The entire portfolio will suffer small losses during this sell off period. Nobody knows when this will end. We may expect some improvement after the presidential election in November or later next year. Since then, no new trades shall be opened. For the upcoming period I will not take any action. I will contribute to the account with some cash making myself ready for future uptrend. It is difficult to be just waiting and looking at the portfolio showing red numbers, but there is no other way to do.

Last Friday AFAM has touched its 50 MA average on high volume. It started dropping as a rock and it was scary move. I mentioned that this move would be a correction only if the stock bounces back on high volume and it would be a good opportunity to add more shares to the existing positions. The stock did it today. It gapped up on huge volume. See the chart.

The question is however whether this move is enough to consider additional position in this stock. The market responded to crazy news about the Government bailing out Freddie Mac (FRE) and Fannie Mae (FNM). Was the entire market running up like a bull just to crash tomorrow? Since the market is in correction and today’s move cannot be considered as reasonable (almost all stocks jumped up just because of the above mentioned information) I would recommend further confirmation on AFAM’s move. If the price will continue up on rising volume tomorrow it would be a signal for adding another position.

A turbulent market with deep losses turned the trend back to correction. It is difficult to recognize whether this would be the time to give up positions and sell stocks. It requires some experience to find out that a particular stock in investor’s portfolio displays a red flag saying: “This is not correction, I am heading down.” What is the correct sell signal? William O’Neil describes two sell signals – climax run and retreat to 50 MA. However an investor needs to be trained enough to tell whether it is just a retreat and stock would potentially go back or it would never return. AFAM is the stock which gapped up at the beginning of May 2008 and since then it run up more than 100%. It doubled invested money. It grew up continuously without break and it topped last week. John Boik in his book Monster Stocks: How they set up, run up, top – and make you money describes this retreating signal and how to recognize it correctly. He says that if the stock runs south on high or huge volume and crosses 50 MA line on huge volume (or high) it is a sell signal. However if the stock runs down and crosses or touches 50 MA on low volume it probably will not continue in a downtrend and if the stock turns back up on huge volume and starts going back up on high volume, it is time to buy more shares.

Well and now let’s look at AFAM‘s chart:

This week the stock retreated from its highs. It is understandable move when considering  that the stock doubled in price within four months. It retreated about 15% – 20% down which still is within a range of a regular correction. However when I look at the volume it was falling down sharply on high volume and volume was growing the whole week. Yesterday the stock dropped deeper but by the end of the day it paired a half of its losses. Today it opened even lower, but by the end of the trading day it closed almost near of intraday high and what is the most important, the volume dropped significantly. Is this the sign of resilience to continue further down? Are there no more sellers? Is this the pattern saying that the stock touched 50 MA on low volume so no big deal it is just a short time correction and next week it will continue back up?

Let’s wait what AFAM will tell us next week. If the stock turns back up and starts growing on high volume, it would be a good opportunity to buy more shares and I will add another position to my existing one. If the stock will continue down on high volume, it will be the time to consider selling it.

In the previous post I was talking about money management I apply on my trading. In summary this is my settings:

– maximum draw tolerance 25% (if all my trades will be a failure my account will loose 25% of its value)

– maximum risk per one trade (stop loss per trade) 5%

– with these rules I could open only 5 positions at the same time

– maximum size of an initial position $463.6 (w/ margin; w/o margin $297.6)

My goal is to decrease all risk to minimum while I could be able to open more positions (up to max. 10). With small money I understand that the account will be riskier than the account with larger amount of money available to invest. However right now I have margin available and this gives me an opportunity to change the risk control setting closer to my goal:

– maximum draw tolerance 20%

– maximum risk per trade 3%

– maximum open trades at the same time 7

– maximum size of an initial position $278.2 (w/ margin)

Discipline and patience is alpha & omega of any trading or investing. Without it an investor would experience huge losses. I have my own experience with lack of discipline and patience. I lost about 60% of my initial principal when I started trading about three years ago. I still fight with my emotions. My biggest issue is waiting when the market does nothing. As many other beginning stock operators I want to be rich quickly. Unfortunately there is no “get-rich-quickly” method how to trade stocks. Any such effort will result a huge loss. Of course an investor may be lucky enough to make fortune in the stock market, but it doesn’t work that way too often. It was my hardest lesson I have learned – and paid my big tuition for it. There are some steps every investor should do prior he starts investing or trading stocks.

Create your investing plan

It is easy said, but how the beginning investor can create a plan when she has no clue how to do it? To be honest, I struggled a lot before I could create my own. A lot of books or other sources talk about investing plan, loss plan and money management plan, but none of them tell the reader how to do it step by step. In one of my next posts I will tell about my own investing plan and loss control plan.

Write it down

Once an investor starts working on her investing and control loss plans it would be the best idea to write it down. Everyone can do it either by writing her own blog, or a paper trading journal. I myself created my investing and loss control plan in Excel spread sheet, so it does some of my calculations for me. I have it saved on my flash disk and carry it with me wherever I go. So I always have access to my investing plan. I never invest in the stock or fund prior looking at the plan to see where I am and whether such investment will fit the plan.

Stick to it no matter what

This is the most difficult part in investing. I always struggled to follow my plans by double guessing. I always asked myself whether the plan would really work or should I modify it? I think, investing into stocks is very easy process with no science behind it once an investor has a plan. I wanted to find a system which would allow me an automatic investing into stocks without too many science-work. Some books I have read recently (i.e. The complete Turtle Trader) comply with it. Once an investor set up his rules he can invest no matter what and there is no need to ask further questions. For example CAN SLIM system encourages investors to perform stock timing. I agree with this, however I feel this very difficult to apply it as a beginner. There were very successful traders such as Dan Zanger who turned his $10,000 account into $42 millions because he successfully applied timing and pyramiding. I set my rules how to enter the positions and when to leave the way it allows me to avoid excessive stock chart studying and determine when is the best time to enter. My screener and rule tells it to me right on time. The most important is to stick to it, don’t ask any questions.

When I say stick to the investing plan no matter what, how can investors recognize that their plan is the right one and it works? An investor can always test it on paper trading as I am recommending in my previous post by opening a Stock simulator. During the savings process an investor will have enough time to test her investing rules and plans. After she saves enough to start a real life investing she should know whether her plan works or not. I am not such a person and I wanted to test my rules in real life. So I started investing immediately and tested my rules during the investing process. However you do not have to do it this way.

Learn opening new positions only after referring to the plan first

One of my mistakes was I had my portfolio ticker opened in my office on the second monitor. It was nice watching how the stocks were doing, mainly when they were growing. Most of the time I ended up caught in the trap by jumping into the position and out. The best way how to spend all your money on commissions. At least my broker was very happy with my trading. This is why I was awarded with a special treatment from him so some of the trading tools I have for free now. However the tools won’t make me money. Today I do not do it anymore. I check the prices, but do not open any position until it appears on my screener and I check my Excel spreadsheet rules.

I am learning to stick to those rules as any new investor must do the same. It is not easy process to survive all the temptation, but the discipline will improve results of anyones investing.

I am still talking in terms of a small account, small money. In my previous post I told that every small beginning investor can start from nothing. If an investor sticks to the saving plan by transferring a little share of her salary into a savings account, soon she will end up with some good starting amount of money. Also her behavior will change significantly, because she will learn saving money instead of living in debt. I am surprised that many Americans live in huge debt and mostly those people who cannot afford it use credit cards or any other type of loan to buy things they do not need and make themselves end up in even deeper debt. Saving small amount of money can teach everybody how to manage personal money to get out of the debt and create some reserves.

However I assume that an investor is free of debt or he saves some portion of his salary while paying the debt off.

When investor’s savings account shows some money, transfer them into a broker’s account. If the new investor is not familiar with stocks, she may start investing into ETFs or Mutual Funds. However at the very beginning I wouldn’t recommend investing into ETFs with small money. It is very expensive. If an investor can invest only $150 a month it would be very painful investing into a single ETF every month. Because ETF is traded like a stock he will pay commission every time he sells or buys ETF. With this little amount the commission will be 6% (it depends on a broker, but with TD Ameritrade i.e. the commission is $9.99 per trade, so $9.99/$150 = 6%).

I would recommend investing into NTF Mutual Funds instead. The advantage is that there will be no transaction fees involved when buying or selling NTF Funds. The disadvantage is that the funds still require minimum initial investment. The investor shall save the initial investment on her savings account first and then transfer the money to her broker and purchase her first fund.

You can pick some funds as I did for investing to diversify. Since I have two accounts – one for stock trading only, second is my Roth IRA where I invest conservatively. I selected those funds in my IRA account:

I recommend that you should do your own research on NTFs prior investing. I wanted to have more aggressive portfolio and I believe this allocation reflects it.

With this starting portfolio I will invest $150 every month into one fund and rotate my investments. Those funds, which require larger initial investment I will save the amount on savings account first, then transfer the amount into IRA and invest it later.

There is a very good article on investing small money on MSN Money by Richard Jenkins, however unlike him I wouldn’t recommend investing into ETFs at the beginning. Originally I started my IRA account the way he recommends in his paragraph but later I realized how expensive it was (unless you trade with no commission broker). If an investor still insists investing into ETFs, the only recommended way to do it is via saving small amount on a savings account first and invest at least $500 (better $1000) into ETF later.

Next step is re-balancing the portfolio. R. Jenkins describes it very well and I stick with this method. I invest into each fund accordingly to keep the allocation at the target. For example when I invest the initial $1000 into RYMBX the allocation will be more than 5%. The next investment will be located into other funds to bring them up to targeted allocation and I start investing into RYMBX again after other funds will meet allocation target.

This investing strategy is for a very long haul. I do not trade these funds, I invest into them. I apply a dollar averaging strategy unlike trading stocks I believe investors can do it with mutual funds or ETFs, because the risk of bankruptcy of a fund or ETF is a lot smaller than individual company. Applying dollar averaging into Enron would ruin a part of investors’ portfolio. There fore I trade stocks, but invest into funds.

I will trade only a small money account. The truth is I do not have more money to trade with. My account was originally larger than it is now, but this is a different story which I will explain later. My problem was that I was not disciplined enough to follow any rules given.

I am working on it and I set up rules which I am learning to stick with them as much as I can. Believe me, it is very hard. There is so huge temptation out there, impatience, quick-rich wishes, double guessing and more and more. The best way how to keep oneself on track is write your plans and rules down. This blog is not only the record how I am doing, how I did from the account inception, but it serves to me as my journal. If any trader decides to follow this way of managing her trades I would recommend either creating a journal log or this Internet blog. Not only others can see what the trader is doing, but even she can have this blog always handy without carrying any paper logs. The blog is always accessible wherever the trader is even from someone else’s computer.

However – never, ever write down any personal data on internet, no account numbers, passwords, nothing. Only the ideas and numbers displaying the account development can be used.

Today I deposited the last $150 dollars to my account so the total value of the account is slightly above $2,000 dollars. The broker allows me to use margin, so my buying power is now about $4,700 dollars.

To trade efficiently I created a money management plan which includes the total amount of the account can be invested, how many trades can be opened in one time etc.

The first rule is that I never use the entire account amount at one time. The rough rule is if the account doesn’t use margin, I invest only about 50% of the portfolio principal. If the account uses margin, I use as a principal 65% of the buying power and than I trade 75% of the new buying power. This will always protect my account against over-trading. I remember once I invested all my money even all my margin. When stocks dropped, margin was killing me and I had to start selling losing positions prior stop loss orders could be activated to cover margin calls. So I was killing my trades even when they showed one or two percent of loss which still wasn’t the reason for selling.

Next rule in the money management is that every open position can lose only 5% of the entire account value. Since I do not use the entire value for trading, this rule allows me to set the stop loss order deep down to 50% of any single position. It means that if one open position loses 50% of the value, it still will equal to only 5% of the entire portfolio value. Such a drop in a stock price won’t occur so often so with this stop loss I am protected against the market volatility. It seems pretty drastic to use 50% as a stop loss, mainly when almost every rules based on CAN SLIM or similar trading system say “cut your loses quickly at 7% – 10%”. If a trader sets up the stop loss 7% below his initial entry price, he would be stopped pretty quickly in a volatile market. It happened to me in couple last years when I became collecting 7% loses one after second. I know there are opponents who may say that when a trader enters the position in a proper time, when a stock breaks up from a sound base, he wouldn’t experience such bad results. Well, how many of new investors and traders are experienced enough to recognize such bases and proper buying points? I am definitely not one of them. I am also busy during a single day so I was looking for a strategy which can provide me with a peace of mind and I would not be required studying stocks so often and still making money. The Reverse Scale System (RSS) is the right solution. So even if I lose 50% on a single trade, it still will be only 5% of the entire account.

The next important rule is the number of open positions at one time. I plan to have approx. 10 open positions, but with such a small account it is not efficient. This account will always be riskier than larger one, but there is no other way how to do it. Everyone can always add more money and use different ratio between maximum draw down tolerance, opened trades and the entire account value. Since I have a very small account now, I set up my draw down tolerance to 25% of the entire portfolio. Since every single trade can lose only 5% I can open max 5 trades at one time. When the account value starts growing, I will change the control loss plan accordingly to afford 10 open positions and still be losing no more than 5% (actually on this, the goal is 3% only). However this will be adjusted later as the portfolio will grow.

Conclusion:

1) I will trade only 50% – 75% of the buying power of the account.

2) I will set up the stop loss order on each open position immediately after buying an initial position.

3) The stop loss order will be set up to a such value so when activated I will lose only 5% of the entire porfolio.

4) I will have only 5 open positions at one time (later this rule will be rebalanced).

5) I will keep track of any new buy with explanation why I have entered the trade (you will be able to see it on this blog as well).

6) Prior taking any new position I will calculate the loss control plan to see where the stop loss is and whether I am in the allowed limit on such a trade. By doing the calculation, I can determine not only how many positions I can take, but also how large the position can be to stay within the limits for possible loss. For example every initial amount which can be invested in a single trade was around $290 (before margin). After the margin was allowed I would use $466 dollars for a single position. These values when multiplied with max allowed open positions shall be within 50% – 75% of the entire portfolio, if not I will be over-invested.