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Bulkowski as Mentor

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As of 02/15/2019
  Industrials: 25,883 +443.86 +1.7%
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2,825 or 2,650 by 03/01/2019

Written by and copyright © 2005-2019 by Thomas N. Bulkowski. All rights reserved. Disclaimer: You alone are responsible for your investment decisions. See Privacy/Disclaimer for more information. Some pattern names are the registered trademarks of their respective owners.

This article discusses tips on learning to trade the stock market by building a trading plan. Thanks to Vicky Wong for her help with the article.

Initial release: 10/17/2017


Mentor: Summary

One of the questions I'm asked frequently, is "Will you be my mentor?" I decided to write this article so I can steer those requests to this page. If you follow the tips in this article, you can learn to trade and maybe, just maybe, you can make money trading as well.

That's not a guarantee of success, mind you, but at least you'll understand the basics.

Mentor: Trading Plan Considerations

What we want to do is build a trading plan for each trade. Why? Because as discretionary traders (those not using an automated buy/sell system) the closer we can get to a mechanical system, the better our trading performance.

Think of it as a blueprint. If you follow the blueprint, you'll have a better chance of success. You'll know what to do when the unexpected happens because you're prepared for it.

Here are a series of questions you should know the answer to. If the questions/answers won't change even as the trade does, then there's no reason to include it in your trading plan. Questions specific to a trade should go in the plan.

  • What do you want to trade? I trade stocks. Some of you may be trading futures or options or other vehicles. You should have different trading plans for different securities. For example, trading an option contract successfully requires a higher degree of skill and experience than trading a stock. You don't want to confuse 100 contracts for 100 shares, for example.
  • What's your edge? If you trade using Elliott waves, then that's your edge. My edge is chart patterns. Find some technique you're interested in and learn when it works and when it doesn't. If you find it doesn't work for you, then try something else. For this article, let's assume you wish to trade using chart patterns.
  • What are the market conditions? Now that you have selected a technique to use, under what market conditions will it work or fail, such as during choppy and volatile markets, range bound, or trending?
  • How is the industry doing? If the majority of stocks in the industry are suffering, you're stock may suffer, too.
  • What I do is count the number of stocks in the industry moving higher versus those moving lower. As a gauge, I use 1, 2, and 6 months as the basis for comparison (that is, is the stock higher than it was 2 months ago? That kind of thing).

  • What is the stock trend? Is it trending up, down, or moving sideways? Do you expect the trend to change? I use the same 1, 2, 6 month price comparison as for the industry. If the stock is higher over those periods, then it's in a strong uptrend. Patternz has a relative strength feature where it will compare the performance over time versus other stocks. So you can use that as a gauge.
  • What's your trading time frame? I trade the daily charts most often. At least, that's where I plan my trades. I'll look intraday when placing the trade, but might reference the weekly or monthly chart to see the big picture. Make sure you trading plan specifies what type of time frame you'll be trading. That way, you can sort by that time frame to see what works best for you.
  • Top

  • What's your position size? How much money are you going to use in this trade? If you're learning to trade, then keep the number of shares you buy small (or you can paper trade).

    For position size, I follow a formula I developed. It uses the market and stock volatility and it's beyond the scope of this article. You can find the formula on page 14 of my book, Trading BasicsTrading Basics: Evolution of a Trader, pictured on the right.

  • How many trades at once? If you're a beginner, then start with one trade with real money at work. If you're paper trading, then you can put on as many trades as you like. You'll likely discover how many trades you can comfortably follow.
  • What chart pattern are you trading?
  • What are the entry conditions? That is, describe what it will take to generate a buy signal. Will it be a moving average crossover? An upward breakout from a chart pattern? Or maybe after a throwback completes? How will you know the throwback has completed? Detailed answers to these questions should be in the plan.
  • Am I going long or short? Leave short selling to the professionals...but it's your money. You decide.
  • What is the profit target? Or will you let the trade go until you get an exit signal? For swing trades, I often use a price target as the exit signal. Long ago, I developed a bad habit and looked to see how much profit I had racked up in the open trade. When it reached about $2,000, I'd sell. I discovered that if I held longer, I would have made more money. So now I avoid looking at the ongoing profit. I know that if I trade correctly, the profit will come. Focus on trading, not on money.
  • What is the exit signal? How will I know it's time to sell?
  • What is the stop loss? How much are you willing to lose? Is the percentage too high for this trade? Are you keeping losses reasonable? Are you selecting stocks too volatile? Often, stocks priced low (below $20, especially below $10) are more volatile than higher priced ones. That means wider stops and larger losses for the cheap stuff.
  • What is the estimated hold time? If the stock goes nowhere in x time periods (price bars, minutes, days, weeks, you pick), will I sell?
  • Should I scale into a trade? That is, when do I buy more? Is the stock moving down or up when I buy more?
  • Should I scale out of a trade? Should I sell a portion if the stock hits $x or x%?
  • Where are support and resistance levels? Where do I expect the trade to sell or reverse? If the stock reverses, how long do I remain in the trade, waiting for it to recover? What happens if the stock makes a vertical run up or suffers a dead-cat bounce?
  • Do I trail my stop higher as price rises? If so, how far below the prior day's close should I trail it (2 or 3 price bars back, x% or $x)?
  • If I'm trailing my stop, when should I narrow the stop? (I often do this during a vertical run, setting a stop the lower of the prior two price bars, knowing the run's end is near).
  • Should the inbound trend be short or long or does it matter? My book, Chart Patterns: After the BuyChart Patterns: After the Buy does an excellent job explaining this and applying it to chart patterns.
  • Is the chart pattern near the start or end of a trend? Define what 'near' means to you. How long is the inbound trend, that is, where does the trend start? Obviously, the closer the chart pattern is to the start of a trend, the better.
  • Is this a busted chart pattern? If the chart pattern busts, how do I handle that? Should I trade busted patterns only? How have they worked in the past?
  • How much, if any, leverage (borrowed money) will I use in this trade?
  • Have I set a financial goal? How much money will I make this week/month/year?


Mentor: Trading Example

Picture of the AJRD.

Let's look at an example to see how the trading process unfolds with the building of a trading plan.

Look at the above chart of Aerojet. I found the Eve & Eve double bottom on the daily chart, but will flip to a longer-term chart to check the trend.

This chart is on the weekly scale. AB shows the double bottom, unconfirmed at this point. That means price hasn't closed above the peak between the two bottoms yet.

I drew horizontal red lines to show where overhead resistance might block or hinder an upward move. Peak C is at about 23.50. D is at 24.35. So those are areas where price might reverse.


Picture of the AJRD.

Let's look at the daily chart, shown above.

AB is the double bottom. C is the confirmation point. A close above C means it's a valid chart pattern.

D is a broadening top chart pattern. It's a top because price trends upward into the pattern. That's clear on the weekly chart (the prior chart).

I extended the top of the pattern, E, because it might become a resistance area as price climbs to meet it.


Mentor: Trading Plan

How would I build a trading plan from this? Let's begin by filling in information from a template

Date: 7/13/2017
Security type: Stock
Name/symbol: Aerojet (AJRD)
Trade style: Eve & Eve double bottom chart pattern, swing trade using end-of-day data
Max position size: $31,000 (found automatically). 1,400 shares @ 22.52 (breakout+.01)=$31,528.
Thinly traded? No (841k avg vol according to yahoo).
Volatility stop: $21.17 or 4.3% (found automatically). Stop used: below lower of two bottoms, $19.95, just below support at 20 (round number). Potential loss 11%. Ouch.
Trailing stop? No, but I might manually raise the stop as price rises.
Measure rule target: 22.51 + (22.51 - 20.06) = ~25.00. That's the pattern's height added to the breakout price
Scaling in? No.
Scaling out? Sell 500 shares at $23.79. That's where trendline E is on the above chart, on 7/13. Sell 500 at 25, the measure rule target. Sell the remaining 400 at 28.75 which is the median rise (27.79%) for double bottoms with scores above 0 (see my book, "Trading Classic Chart Patterns"). As one order fills, place the next sell order.
Resistance levels: Once it clears 24.35, it's making new highs.
Support levels: 20, 18
Score: -1 (Patternz using manual score).
"After the buy" setup: Figures 5.5 and 5.8 apply. Both suggest a sustained upward move.
Trend start: 4/26/2017 (found using Patternz), the nearby peak, so the inbound trend is short.
Busted chart pattern? No. If it busts, I'll be stopped out.
Leverage? None
Entry conditions: Place a buy stop at 22.52, a penny above the pattern's high.
How long to wait for it to make a move? If the stock hasn't made a move upward in a month, then I'll consider selling.
Exit conditions: See above scaling out targets
Next earnings: 8/3/17, or 3 weeks away. Yuck.
Weekly scale (a scale longer than the usual trade): The stock is near new highs, trending upward.
Reversal or continuation? Reversal
Relative strength (Patternz option): 3 green bars: week, month, 3 months, all of which is good.
1, 2, 6 month S&P trend: Up, up, up. (found automatically)
What are the market conditions Long term up trend, with inverted and ascending scallops predominating.
Industry trend: 1 month: 10 stocks up, 1 down. 2 mos: 10 up, 1 down. 6 mos: 8 up, 3 down (found automatically)
Comments: I'm worried about the stock stalling out at the old high of 24.35. Earnings are just 3 weeks away, so that's a concern. This could dead-cat bounce, but my guess is it won't. The price action over time (see above Relative strength and Industry trends) supports a continued move higher. Once it breaks out to a new high, most overhead resistance disappears.


Mentor: Trade Aftermath

Picture of the AJRD.

Price hit the buy target the day after it was placed, filling at 22.52 (the buy stop price). A stop loss was entered (see Initial Stop on the chart), priced at 19.95, below A, the lower of the two bottoms and below support at 20.

The stock did not throw back, increasing the score of the pattern to +1. That suggested the trade has a decent shot of hitting the median rise for scores above 0 (meaning a climb to 28.75 looked favorable but not guaranteed).

The stock hit the first target of 500 shares @ 23.79 on 7/25, at the day's open, filling at 23.85. A new target to sell at 25 was placed.

The stock stalled near the 2015 high of 24.35, just as predicted. This formed a small knot of congestion that the stock had to push through (below C).

When earnings came out, the stock gapped up higher on the news, filling the second target (500 shares at 25.00) order, filled at 26.66 on 8/4/17. That's a gift. A new sell order for the remaining 400 shares @ $28.75 was entered.

As the stock moved sideways, it formed an ascending triangle (shown at D, in cyan or whatever color you call it). I placed a stop loss order at 25.80, a penny below the bottom of this pattern. Why?

I know that a week to 10 days after a good earnings announcement, some stocks will start retracing, giving back their gains. That didn't happen in this case, but I didn't want to sacrifice too much profit if it retraced.

Due to the appearance of the ascending triangle with an upward breakout, I moved the target sell order of 400 shares (not the stop loss order) upward from 28.75 to the measure rule prediction for the ascending triangle. The height of the triangle was 27.95 - 25.81 or 2.14 for a target of 30.09. I set the sell target to 29.93, just below round number 30.

The last sell order for 400 shares filled on 9/1/17 at 29.93.

I consider this trade to be risky, given the close proximity of the earnings release. The stock could have tumbled just as easily as climbed. But it worked out well. I didn't expect an ascending triangle to appear, so my trading plan needs to be adjusted to handle additional buy signals.


Mentor: Scoring

Picture of the sample spreadsheet.

To make a trading plan meaningful, you need to be able to track your performance. I suggest building a spreadsheet (xlsx, 14.5kb, a portion is shown above) to track details of your trade. That way, you can sort by those details and determine which setup is most profitable.

For example, do trades made on Monday perform better than on other days (best for day traders)? Which works best, day trading during the morning hours, lunch hour (east coast time, that is), or during the afternoon session?

Here are some questions you can ask your spreadsheet:

  • Am I over/under trading? That is, count the number of trades per day/week/whatever and see what happens to profits.
  • Do reversals or continuation patterns perform best?
  • Did I buy too early, too late, or just right?
  • Did I sell too early, too late, or just right?
  • Did this trade follow the trading plan? Is yes/no, how did it affect profits?
  • Have I met my day/week/month/year $ or % goal?
  • Is my win/loss ratio too low or doesn't it matter?
  • What is the best price for a trade?

-- Thomas Bulkowski


See Also

Written by and copyright © 2005-2019 by Thomas N. Bulkowski. All rights reserved. Disclaimer: You alone are responsible for your investment decisions. See Privacy/Disclaimer for more information. Some pattern names are the registered trademarks of their respective owners. Good advice is something a man gives when he is too old to set a bad example.