Tom Dorsey Q&A Part 3. Wednesday, Feb 18
Q) This is the first rough draft of my new methodology (probably widely used and I am not aware of it). I planned to see what would happen if I bought on major trend reversals up and sold on major trend reversals down. The only adjustment I made to the model was to sell on anything that showed a 20% increase over my entry point.
The idea of using a percentage gain to trigger a sell came when I realized that in a lot of cases the reversal ate a lot of the potential profit. The wisdom of this approach is one of the things I wondered if you could comment on.
It is a two edged sword because it also triggers a sell far short of the top in big runs. Have you ever heard of such an approach?
I know from past experience that my original ideas sometimes appear in publications quite a few years before I think of them. It is possible I haven't read far enough into the book yet. The number 20% came out of my head and probably could be adjusted but I haven't messed with it too much yet.
Does any of this make any sense? Thanks for your help and any input you have on these ideas.
A) You are on the right track in thinking that the reversal or sell signals, when it develops, often results in mucho lost profits. We will stop any position when it rises 20 boxes then reverses 3 boxes and we also sell
1-3 of our position if it rises 30% and another 1-3 if it rises 50%. Same concept. There are many right answers in the market.
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Q) Do you make any adjustments for Options Expiration?
A) The only thing we do on option expiration is, place an order to 2 points higher than current price in a stock you want to sell and visa versa in a buy. Both might get off during this week.
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Q) From my limited knowledge of what traders do, if NE moved above 30.5 before next Friday it would be a blip, so buying above 31 would ensure that you paid the highest price of the week. On the other hand, it is likely that a stop at 25 would get taken out on a momentary slip to 24.5 ensuring that you sold at the low of the week.
The theory is basically that if you bought 25 calls last week you would take the free short of common above 30.... well, you can work through all the scenarios, but the idea is that profits are locked in whether it closes 25ish or 30ish on Friday. (This is not a manipulation theory, just what I was taught about why the common is
usually pinned to the strike at expiration. The general market/sector direction determines it is 25 or 30. It would take very good or bad news for it to not close near one of those strikes.)
So what I am trying to ask (you or Tom) is if it might be better to lower both the stop and buy price about 1/2 for the week. Is that against the rules?
I'm more concerned about placing a stop right at the strike price. Since the stock is right in the middle now, there is (in theory) a 50/50 chance of that 25 stop getting hit, but not much chance of the stock closing the week below 25 (unless something awful happens)..
A) You have some very good ideas here and I will go with them. You are right on the options as forward and reverse conversions are in play during this week. Good idea.
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Q) NMSS is a stock that has done very well for us. We are currently up 350% or so. We have a core holding of 1400 shares. We have traded this stock fairly successfully from time to time maintaining a core holding. I feel as though the market is due for a correction, Asian flu is one possible cause of numerous possibilities. So, I want to start a sell program with NMSS. Could you suggest a sell program? Do you think we should continue to hold any long or sell them all considering our huge gains?
A) I would begin to sell calls against your large positions in NMSS.
This takes the emotion out of selling. I would begin with some 5 points in the money and some at the money and possibly some out of the money. The in the moneys I would look at as cash but considering the chart pattern you just might need some big premium as protection. Using calls like this take the emotion out of selling and will allow you to pear back this position to something more manageable. You have too much exposure here.
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Q) How do you view the market?
A) On the market I typically don't predict. Right now we have the ball but I do know that the NYSE Bullish Percent has had a very high propensity to reverse between Jan-Feb-Mar. When it does, if it does we will take action. Drive as straight a line as possible.
Keep it simple.
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Q) Although it is very difficult if not impossible to time the market I feel having some cash on the sidelines could be a smart thing right about now. What would your take on this be?
A) We will put up some cash when the Bullish Percent indexes suggest so. Right now things are fine.
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Q) We got into SUNW at 31 in Oct when the market lost those 500 points. It has gotten as high as 49 and is currently at 44. If I wasn't thinking long perhaps I could have taken advantage of this pullback. Instead my strategy is "I'll buy more if it goes below 42." I feel there is something fundamentally wrong with this thinking. Do you concur?
A) With the long term trend of SUNW decidedly up, OK to buy at $42.
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Q) How do you employ a stop effectively?
A) Stops can be trailed up in a stock you have profits in. Typically we will use potential new sell signals that develop as potential stops if they are given. Trend lines are also used as stop points. Stops are one of the hardest thing to use. It always seems when you stop out, the stock reverses and rises. This does happen in some cases. Fundamentals are important to consider. If they remain as good as you understood them to be initially you might want to give the stock more room. |
