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VIP Buy signal

September 10, 2007

When we came up with the first five stocks in our new list, VIP was one of them and quickly gave a buy signal according to our group rules. I emailed the group asking how one might view this and place an order to buy. I failed to specify that I meant it in the context of our group rules. Nevertheless, I was a bit disappointed to get only a few responses to the question and none that answered according to all of the work we had done lately on developing a group system dissecting the Investools method. I know that we had yet to “officially” start paper trading the group list, but still the exercise is a good one.

So here is the question from August 31 and roughly what I was looking for:

Q: Would anybody venture to explain why VIP should be a buy today? And to set up how the trade would be sized for 2% risk on a 100K portfolio? How many shares would you buy and what would the order to be placed look like?

A: VIP is in a group ranking in the green on the big chart and one that showed sideways to upward movement. The stock was in a long term uptrend but had recently pulled back from a potentially strong resistance point and even formed a short term downtrend with a lower high and lower low as outlined the in the downward channel on the chart. It gave 3 green arrows, but in the context of a sideways to downward moving stock(with the MA moving downward), it should be considered not buyable. However, on 8/30 it broke out above resistance with double the average volume. This qualifies it as a breakout buy.
(Click on images to see them larger.)

One of the rules we had come up with was to not buy stocks that were more than 10% away from the MA. This would disqualify this stock, but my feeling is that that would prevent a buy of almost any breakout buy. So I think it is appropriate to apply that to breakouts as “no further than 10% above the broken resistance level/expected new support level.” This is an example of the type of thing that will show up and need discussing/deciding in the process of trading and refining our system(or any system). (I now look back at the rules and see that it does include specification of 10% above the MA OR BREAKOUT SUPPORT LEVEL. Perhaps it could be worded more clearly, but that does give the go ahead like I just described.) The official group rules can be found in the “Files” section of our Yahoo group.

The resistance line as I’ve drawn it was 23.41. (Remember that these are areas, not exactly lines. Part art, part science.) With a close on 8/31 of $24.73, it is about 5% above the breakout level/former resistance/assumed new support level and well within our 10% requirement.
Now to figure out how much to buy and place the order.
With a $100,000 account and a risk tolerance of 2%, we are willing to lose $2,000 in this trade. To figure out our position size, we must first figure out where we’ll put our stop loss (stop sell) order. We will use 3% below the assumed new support level. To use a simple round number and to give it just a touch more room due to market volatility, I’ll use 23 as the new support level. To easily find 3% below support , multiply that level, 23 x .97. That gives us $22.31.
So now we know that we’re going to place a buy order at a limit of $24.73(the closing price on the breakout day) with a stop loss order at $22.31. 24.73-22.31 gives us total risk(potential loss per share) in the trade of $2.42.
We then take our acceptable portfolio loss amount of $2000 and divide it by that number representing the risk in the trade. $2,000/2.42=826. We can buy 826 shares and be perfectly positioned for our calculated portfolio risk as tailored to the risk in this particular trade.
But because I would prefer to deal in round lots because it’s simpler and matches up nicely with potential hedging with options(buying puts or selling calls) I’ll round down to the nearest hundred. So 800 shares it is. This will use $19, 784, under our limit of 25% of our account.

For market open the next day, I place an order to buy 800 shares of VIP at limit of 24.73. Using a “1st trigger sequence” order on Thinkorswim, I line up a second order to be triggered upon filling so that there is instantly a standing “stop sell” order to sell 800 shares of VIP if the stock goes to or below $22.31.

Here is what the order should look like. Notice the GTC(Good ’til cancel) on the stop order. The buy order has a day order, meaning that it would expire if not filled that day. Upon expiration, it would also cancel the stop order.

The next morning, the stock gapped higher at the open and then came down to fill the order at $24.72 at 9:55 AM. The level has held and the position is showing a profit of 1.82%, which is encouraging considering the carnage on Friday in particular.

I hope this has been clear and helpful to those who are still uncomfortable with how to setup a stock trade and place the appropriate orders. Please feel free to chime in in the comments section with any questions or comments.

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