Becoming a Better Trader: Legging In
The next time you desire to buy a stock, consider watching it for a while to get a better feel for its movements.
I continue my series today on trading rules looking at a specific method by which one should consider actually placing a trade. Unfortunately, many of my trading rules exclude smaller accounts of, say, less than $25,000 and I have appreciated the feedback discussing this. To address it, I believe what I will do is discuss in one piece a rule book for those with a small account, to come at a later time.
Buying in stages is a strategy I don't see discussed much at all unless of course a stock immediately plummets shortly after buying. It's at this point many foolishly believe that buying more is a good way to average down and improves their chances of performance, however this is not exactly the "legging in" I am talking about.
There are countless trading styles and I have seen many that work incredibly well. Typically a person's trading style and their rules will correlate with their personality. For example, if you are more interested in spending your days strolling along the river banks, reading art history and an exciting evening is cuddling up with poetry, you probably want to shy away from the high beta stocks such as VMWare (VMW) and stick with the slow movers like Johnson and Johnson (JNJ).
You probably aren't concerned with exact entry points, rather your time frame for holding is years not months. If, however, you are like me, falling in between the Gordon Gecko and Warren Buffet styles, then legging in and legging out of whatever you are looking to play may just help you to keep the emotional levels in check while still being able to play higher beta names without one terrible entry price wiping you out.
If you missed the beginning of Prof. Tatro's series, Becoming a Better Trader, you can catch up with the preceding columns here: Developing Your Personal Rules, Position Sizing and Let the Chart Be Your Guide.
Having already determined what my maximum position size is for the particular stock I am watching (Rule #1) and having honed in only on what the chart is telling me rather than the outside noise (Rule #2) I am ready to begin. My partial buying rule is really quite simple in theory and is broken down as follows:
1) I will take a 1/3 position as the stock is "setting up": looking ready to advance higher in the near future. I will set a stop where the pattern would be considered broken.
2) Once the set up is confirmed and the stock continues to "act appropriately" I will take another 1/3. The same stop in #1 will apply.
3) I will add my final 1/3 when the stock breaks out and raise my stop on 1/2 of my position should the breakout fail.
The key to this style is to understand what it means when a stock is "setting up" and when a stock is "acting appropriately." It can be frustrating when someone will say something such as this and they seem to believe it makes perfect sense, when you really have no clue what they are talking about. This unfortunately is an integral part and is why you have to resolve to do some work on your own. I mentioned a few books yesterday, as well as my own site, all of which are great resources to better help you understand what these terms mean.
Let's take a look at an actual trade I recently played:
Network Equipment Technologies (NWK) caught my eye as the weekly chart had been basing (moving sideways in a narrow range) for several weeks. I noticed that the stock had created some well defined points of resistance in the $11.15 area from April 2007 and a failed attempt at challenging these levels the week of July 17. I started watching the stock on a regular basis and noticed in late August that the stock was once again creeping towards the resistance levels previously mentioned. On September 4 I took my first piece of Network with intentions of letting it move freely and taking another piece ahead of the break out above the July 12 high of $11.07.
My first purchase price was $10.68. Unfortunately, while the stock faded another day, I typically like to give it a few more days and did not take another piece, the stock did not give me an opportunity to add my second piece as two days later the stock started moving and broke above my next buy point, sparking me to add what should have been my final piece but was only my second on September 6 at $11.08.
Today the stock sticks at $13.91 after last night's close and has been a solid winner regardless of not being a full position on the break. I have since peeled some gains off and continued to trade around the stock.
The question arises, though, of why did I not close out the position on September 7th or the 10th when the stock dipped below the break out point? Well, I will discuss a nuance I always adhere to when it comes to stops that helps me stay in when a stock goes through a rinse that typically takes place just to run stops before heading higher. Furthermore, a discussion can be had about how to sell, but this is another rule completely and you will have to wait until next week.
The next time you desire to buy a stock, consider watching it for a while to get a better feel for its movements. Where is its defined support and resistance levels? Where are your add points and stop points? When you are ready, consider taking only a small piece to start. Make sure the stock continues to act as it has. If you feel comfortable and the stock is still moving in a healthy manner, take another piece and so on.
Buying in stages or legging into a stock not only helps you to gain a better feel for how that stock is trading but it also helps you to remain patient and stay away from the desire to chase a hot stock that is on the move. Furthermore, if you anticipate a move coming and you are wrong, you can close out the position quickly for a minimal loss.
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