Option Investor
Educational Article

Refinement of Strategies

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By David Popper

Is there anyone who has trading down pat? I do not know any successful traders who are not constantly refining their strategies on a routine basis. I felt that I crossed a watershed when I ceased bouncing from strategy to strategy, and instead began to refine the few strategies that I use. It is sort of like that old Kentucky Fried Chicken commercial that said "we do one thing and do it right." Well, doing one thing and doing it right does not mean that you should not attempt to refine and improve your strategy. It does mean that you should develop a consistent game plan and stick to it, while at the same time trying to improve it. It has been said that any strategy will work, if properly executed. By using the same strategy time after time, you are able to notice the small nuances of the strategy. A slight adjustment here and there can sometimes make all of the difference. So all that was said to simply say that I am refining my strategy by further clarifying my buy rules and sell rules. Below I will discuss these refinements.

On the buy side, I want to remain cognizant of the fact that it seldom pays to buy a hot stock in a rapidly rising market. Inevitably, the buying frenzy subsides and the stock sinks under its own weight. Therefore, in making a buying decision, I consider fundamental, technical, and sentiment issues. As far as fundamental analysis is concerned, I limit my purchases to stocks that I wouldn't mind owning. My own fundamental criteria is to buy leading stocks in leading sectors of the economy such as chips, fiber optics, etc. The stock should sport an excellent earnings and relative strength rating according to Investors Business Daily.

As far as technical analysis is concerned, since I am a position trader(meaning I hold stock for a few days to a few weeks or alternatively write covered calls for the current option cycle), in a positive market, I try to buy these stocks off a base or on a dip. In a negative market, I will only make a purchase during extreme conditions, that is when a stock is free falling and settles or bounces AND the technical indicators show an upward divergence.

I sell a stock in an up market when an extreme condition exists. I define an extreme condition in an up market as when the upper trend line is breached AND the technical indicators reveal divergences which indicate that we may be due for a reversal. This does not mean that I will sell right away, however, I will tighten my stops to protect my profits.

By sentiment I mean that I try to trade a stock when there is a compelling reason to own the stock. For example, ORCL reports earnings on September 14th, after the bell. Although the stock may not go up, due to overall market conditions, if the market cooperates, there could be a short earnings run through Thursday. Another example is RMBS. It has an analyst meeting this week. This upcoming meeting gave RMBS to buck the trend and go up 3 points on Monday when the rest of the NASDAQ caved. Finally, there are a host of companies that are split candidates during the next earnings cycle. Many of these are listed at OIN and its sister publications. Simply put, these events cause enthusiasm, and enthusiasm causes short-term price appreciation. Realizing that this temporary injection of enthusiasm is often short-lived, I sell just before the triggering event. You see, the market is made up people and acts just like we act. I remember as a child, one of the most exciting days of the year was Christmas Eve, because anticipation was in the air. One of the most deflating times was Christmas afternoon because the excitement was over. Somehow the toys were an inadequate substitute for the anticipation.

In short, I have used the above refinements to improve my strategy of using half of my account to write covered calls and half of my account to buy dips or to buy stocks heading into an event. I also stay loyal to my strategy instead of placing my loyalty in a stock. Being loyal to a stock is dangerous. Read any message board and you will find a lot of banter about the merits of particular stocks. The bulls claim undying love, while the bears talk about excessive valuations and new technologies which will blow the company's products. Over time, both are right. Stocks will go up and down, analysts will change opinions, and positive and negative surprises will happen. Today's market darling may not be the highflier tomorrow. Remember IOM? How about Dell? It is still a fine company, but an investment in Dell over the past year would definitely not create a banner investment year. Loyalty to a strategy forces you to make stock selections at least monthly. This forces you to stay abreast of the current developments and to continue to trade the current trend setters. In short, it forces you to remain a knowledgeable trader.


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